TOKYO - Japan's prime minister chose his deputy, Naoto Kan, as finance minister on Wednesday after the elderly holder of the post resigned amid worries about whether the government could rein in spending in the face of a frail economy and ballooning debt.

The departure of Hirohisa Fujii, 77, one of the few experienced members in the Democratic Party-led administration, was another blow to Prime Minister Yukio Hatoyama as he struggles with falling ratings ahead of a mid-year election.

It could also put at risk the fiscal restraint Fujii had championed, potentially pushing up government bond yields which hit seven-week highs on Wednesday.

Hatoyama told reporters he had selected Kan -- who has headed a newly created National Strategy Bureau that sets priorities for fiscal policy -- to replace Fujii.

Yoshito Sengoku, now administrative reform minister, will take on Kan's previous portfolio as national strategy minister.

Kan is unlikely to favour big spending, given that public debt is nearly 200 percent of GDP, but he is less experienced in budgetary matters and it remains to be seen whether he can resist pressure to spend more if the economy sags again after emerging from a deep recession.

For a graphic on Japan's fiscal pressures, click: r.reuters.com/paw97f

I don't think Kan's stances on fiscal reconstruction and currency intervention would be different from those of Fujii so he would be neutral to markets, but there is some uncertainty as Kan seems not to have thorough knowledge about macroeconomy, said Kyohei Morita, chief economist at Barclays Capital Japan.

There is a possibility that the government will consider compiling an extra budget if the voter support rating keeps falling before the upper house election later this year and concerns about more bond issuance will remain regardless of whoever replaces Fujii.
Hatoyama took office in September after his Democratic Party overturned almost five decades of unbroken rule by the conservative Liberal Democrats, but his popularity has sagged due to a growing view that he is indecisive.

LACK OF CLARITY

Finding a replacement among the ranks of largely inexperienced Democratic Party lawmakers was a big test for Hatoyama ahead of the upper house poll.

The party needs to win a majority to reduce reliance on tiny but noisy coalition partners and pass laws smoothly and a loss could revive a policy deadlock similar to that which bedevilled the Liberal Democrats after their defeat in a 2007 poll.

Japanese media said that one reason Fujii wanted to quit was because he felt he had been slighted in favour of Democratic Party Secretary-General Ichiro Ozawa in the budget wrangling.

Hatoyama's ratings have slipped to below 50 percent in some polls on voter concerns about his ability to make decisions on policies from a feud with ally Washington over a U.S. airbase to whether to keep campaign promises despite a lack of funds.

The government also suffers from a lack of clarity about who controls policies, as cabinet ministers express competing views and Ozawa appears to pull strings behind the scenes.

Japanese bond yields hit seven-week highs on Wednesday ahead of a 10-year auction but are off higher levels seen in November, reassured after Fujii stitched together an annual budget that held down debt issuance next year.

Fujii was the main government proponent of sticking to a cap of around 44 trillion yen (299 billion pounds) in new bond issuance for the year from April as the government looks to contain a mountain of debt.
Currency markets will be keen to see if Kan shifts to more aggressive jawboning when confronted with a sudden rise in the yen. But picking a level for intervention would still be tough no matter who holds the portfolio, and probably depends on the pace of moves as much as absolute levels.

Democratic Party mastermind Ozawa may have played a key role in the personnel decision, since he was seen to have strained relations with two other possible successors.

That could further undermining Hatoyama's image and fan doubts about who is in control of policies.

Ozawa stepped down as Democratic Party leader in May over a funding scandal, but is engineering campaign strategy and has widely been seen as pulling strings behind the scenes.

($1=91.79 Yen)

(Additional reporting by Masayuki Kitano, Rie Ishiguro, Yoko Nishikawa and Chisa Fujioka; Editing by John Chalmers)

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