Japan leadership race clouds outlook

The Democratic Party of Japan (DPJ), which swept to power last year, is already floundering after the DPJ and a tiny partner lost their upper house majority in a July election.

Below are scenarios for the outcome and their policy impact.

PM Kan Wins Party Vote,

Remains PM

Kan, 63, has a shot at victory even though Ozawa heads the biggest DPJ group, because his opponent faces possible indictment in a funding scandal and is plagued by an image as an old-style wheeler-dealer that undercuts his ratings among ordinary voters.

The key question is whether Kan can defeat Ozawa decisively enough to bolster his clout and unify the party.

In the best scenario for Kan, Ozawa loses by a hefty margin and bolts the DPJ with only 20-30 of the party's 411 lawmakers, spelling the potential end of his four-decade career.

That would allow Kan to consolidate control over the party and concentrate on his efforts to engineer growth while cutting public debt now twice the size of Japan's US$5 trillion economy. The Japanese government bond yield curve might flatten a bit.

A key aide to Kan, however, told Reuters that any victory would likely be by a small margin. Ozawa would then have the option of remaining in the DPJ to exercise clout over personnel and policies, or bolting the party with followers.

Ozawa would have to persuade almost 70 DPJ lower house lawmakers to leave the party to deprive the Democrats of their majority in the powerful chamber and put at risk Kan's grip on power. Analysts doubt whether that many would be willing to join the opposition ranks. But if Ozawa took a large bloc of members with him, that could trigger moves towards a realignment of party allegiances, spelling prolonged political and policy chaos.

If Ozawa remains inside the party after a robust showing in the party vote, the result looks likely to be more bickering, a possible weakening of any drive to curb the public debt by reducing spending, and delay in debating a rise in the 5 percent sales tax. Kan would likely reshuffle his cabinet and might give posts to Ozawa backers, further complicating policy decisions. He would still face the problem of how to win opposition support to enact laws, including bills to implement the 2010/11 budget.

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