July 21, 2009 / 12:51 AM / 10 years ago

FACTBOX: Policy challenges facing Japan's next government

(Reuters) - The winner of an election that Japan’s Prime Minister Taro Aso is set to call for August 30 will face a raft of challenges including the country’s worst recession in 60 years and growing social welfare costs in a fast-aging society.

The cabinet signed off on Aso’s plan to dissolve parliament’s lower house on Tuesday. The main opposition Democratic Party has its best ever chance of beating Aso’s ruling Liberal Democratic Party and its junior coalition partner in the poll, ending half a century of nearly unbroken rule by the conservative LDP.

Following are major challenges for a new government.

ECONOMY

Japan’s economy is mired in its worst recession since World War Two and has edged back into deflation, although recently there have been signs of a tentative recovery.

Aso’s government has planned 27 trillion yen ($282 billion) in stimulus spending since the global financial crisis erupted last year. The Democrats have said the government is spending money on the wrong things, such as a museum of Japanese pop culture.

But stimulus efforts from past economic problems have left a mountain of public debt equivalent to around 170 percent of GDP, the highest among advanced nations, constraining Tokyo’s ability to spend its way out of recession and worrying financial markets about further debt issuance.

The Bank of Japan, with its key policy rate near zero percent, has just voted to extend a series of steps, including buying corporate debt and increased buying of government bonds, to keep funding strains from further derailing the economy.

The focus now is on when the central bank will exit from those emergency measures.

Japanese banks have limited exposure to toxic debt that has wreaked havoc among their U.S. and European peers, but their large holdings of shares have left them with big holes in their balance sheets as stock markets have fallen.

Aging POPULATION, SALES TAX DEBATE

One of Japan’s biggest challenges is to revamp and pay for

soaring health, social welfare and pension bills as a wave of post-war baby boomers retire.

For a graphic tracking Japanese demographics, click:

here

Economists say funding these will mean raising the nation’s 5 percent consumption tax, but the topic is politically touchy.

The Democrats say it will not raise the tax at least for four years, while Aso has said it should be raised from 2011 but only if the economy recovers.

REFORM BACKLASH

Critics say five years of pro-market reforms under Junichiro Koizumi, prime minister from 2001 to 2006, have widened social, income and regional gaps, and both the LDP and the Democrats have sought to distance themselves from those changes, which included postal privatization, deregulation of the job market, and repairing the nation’s tattered finances.

The global recession has intensified such criticism and given some impetus to calls for a return to stronger regulation. Companies worry that trend would be stronger under a Democratic Party government, given the party’s support among labor unions.

FOREIGN RELATIONS

Japan’s leader must address the challenge of China’s rising regional clout, while keeping ties with its huge Asian neighbor and biggest trading partner on an even keel.

Sino-Japanese relations have improved recently after years of friction over Japan’s military aggression in Asia before and during World War Two, but territorial and maritime disputes still simmer along with mutual mistrust over military ambitions.

(Reporting by Yoko Nishikawa; Editing by Rodney Joyce)

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