WRAPUP 3-Japan signals tax reform, seeks to avoid deadlock

* Finance minister says tax reform needed

* Policy deadlock looms after ruling party’s election loss

* Kan to seek opposition help but hurdles ahead

* Support for Kan’s govt drops, adding to woes
(Adds Kyodo opinion poll in fourth paragraph, background)

By Yoko Nishikawa and Tetsushi Kajimoto

TOKYO, July 13 (BestGrowthStock) – Japan’s government said on
Tuesday it had to press on with tax reforms to cut a huge
public debt despite a stunning election setback, and was
looking to two opposition parties to help drive policy change.

Prime Minister Naoto Kan’s ruling coalition lost its upper
house majority in a weekend election, putting his policies to
deal with debt and generate growth at risk and prompting
warnings by credit rating agencies S&P and Fitch on Japan’s
sovereign ratings. [ID:nTOE66C03L]

Kan has another pressing headache: a possible challenge
from rivals in his own party including powerbroker Ichiro
Ozawa, a critic of the sales tax hike proposal, ahead of a
party leadership vote in September.

A Kyodo news agency survey showing support for Kan’s
government had sunk to 36.3 percent from 43.4 percent before
the election could undermine his efforts to keep his job.

His Democratic Party of Japan (DPJ) still controls the more
powerful lower house. But it needs help from other parties to
push bills through the upper chamber in the struggle to end
decades of stagnation in the world’s No.2 economy.

“If we don’t see a credible plan come through by the end of
the year, it will send a negative signal for its rating, adding
pressure to the credit rating,” Andrew Colquhoun, Fitch
Rating’s sovereign analyst for Japan, told Reuters.
[ID:nTOE66C043]

Trying to soothe worries the election drubbing would sap
political momentum for fiscal reform, National Strategy
Minister Satoshi Arai said debate was still needed on a
possible hike in the 5 percent sales tax, one of the lowest
among major economies.

Kan had floated the possibility of doubling the tax as a
way to bring down public debt about twice the size of the $5
trillion economy and to stave off a Greek-style debt crisis as
social security costs soar to care for an ageing population.

Finance Minister Yoshihiko Noda conceded that Kan’s
proposal may have turned off voters in the election campaign.

“But we must carry out an overhaul of the tax system
including the consumption tax,” he told a news conference.

Most opposition parties support an eventual sales tax rise
and the Kyodo survey showed a slight majority of voters do as
well, but Kan’s abrupt floating of the topic and seeming
flipflops cost the Democrats support, analysts said.

Unlike Greece, Japan’s public debt has long been financed
from its massive pool of domestic savings that mostly sits in
the banking system and is recycled into Japanese government
bonds.

But fears are growing that the ageing population will start
drawing on those savings, forcing Japan to rely on foreign
investors to fund its debt and potentially creating market
instability.

The change has already started and Japan’s savings rate has
fallen to about 3 percent from over 10 percent a decade ago.

The Fitch warning of the higher risk of a ratings downgrade
helped send September Japanese government bond futures to the
day’s low at 141.33 (2JGBv1: ).
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See graphics:

PM support falls over sales tax :
http://r.reuters.com/myv63g

Japan’s massive public debt:
http://r.reuters.com/sez92m

Graphic on Japan poll results:
http://link.reuters.com/tys86m

For more stories on the Japanese politics:
[ID:nPOLJP]
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TOUGH CHALLENGE

In attempt to break the political deadlock, Kan told close
aides he would ask the third and fourth-biggest parties in the
upper house — the New Komeito and pro-reform Your Party — for
policy-based cooperation, the Yomiuri newspaper reported,
adding he was probably eyeing a formal coalition in the future.

But Kan, in office just one month, faces a tough challenge
as the two parties have ruled out joining the government,
pointing to a period of political manoeuvring and policy
paralysis.

Your Party, which has 11 seats in the upper house after
Sunday’s poll, could cooperate with the DPJ on getting the Bank
of Japan to do more to fight deflation and on overhauling the
country’s bureaucratic system.

But the party has said it would not join the debate on a
possible sales tax increase, arguing that the government should
first focus on cutting wasteful spending.

The Buddhist-backed New Komeito, which backs policies to
fix the pensions system and social safety net, could agree to
the debate on the sales tax but only if the government first
tackles social security reform.

Bills at immediate risk in an extra parliament session
expected in the coming months include one to scale back postal
privatisation, sought by Kan’s current small coalition partner,
the People’s New Party, but opposed by the Your Party.

Kan has a more pressing threat — a possible challenge from
opponents in his own party including powerbroker and critic of
the sales tax hike proposal, Ichiro Ozawa, ahead of a party
leadership vote in September.

He could reshuffle his cabinet after the vote, Jiji news
agency reported. He is already under pressure to replace his
justice minister who lost her seat in the election.
(Additional reporting by Chisa Fujioka, Umesh Desai, Editing
by Chris Gallagher and Jonathan Thatcher)

WRAPUP 3-Japan signals tax reform, seeks to avoid deadlock