TOKYO - The No. 2 executive in Japan's ruling party vowed on Saturday to stay in his post despite a funding scandal that could scupper the party's chances of winning a mid-year election and raise the risk of policy deadlock.

Democratic Party Secretary-General Ichiro Ozawa was credited by many with engineering the party's huge election win last August and his skills are thought vital to winning this year's upper house poll, as well passing laws and deciding policies.

But the scandal is likely to further erode voter backing for the Democrats as the opposition turns up the heat in a session of parliament from Monday, where the government aims to pass an extra budget for this fiscal year to prop up the weak economy.

A combative Ozawa, speaking at the party's annual convention, lashed out at Tokyo prosecutors who late on Friday arrested a Democratic Party lawmaker who had worked as his aide as well as another ex-aide in connection with the funding scandal.

A third aide, on trial in a separate case, was arrested again Saturday.

I don't know if it was deliberate or not, but the arrests seem to have been timed to coincide with our party convention. I certainly cannot accept this way of doing things, Ozawa said.

I will resolutely push for my own beliefs against this way of doing things, and I am determined to fight, he added to applause from assembled Democratic Party lawmakers.

Prime Minister Yukio Hatoyama, who analysts say relies heavily on Ozawa's clout, said he wanted his lieutenant to stay.

Secretary-General Ozawa has said that he has not broken any laws. As the leader of the Democratic Party, I believe in Secretary-General Ozawa, said the prime minister, who himself has had to apologise for a separate funds scandal.

Doubts about Hatoyama's ability to make tough decisions have already eroded the government's ratings to about 50 percent from early highs above 70 percent.

WHO'S IN CHARGE?

A lack of clarity about who is in charge of policies has worried financial markets as Japan grapples with a weak economy, and ballooning public debt. Machinery orders slumped to a record low in November, adding to fears of a return to recession that would lead to calls for more spending.

Recent polls show the decline in voter ratings had levelled off despite last week's resignation of Japan's elderly finance minister and some market-jolting comments about currencies by his successor. But the widening scandal could again worry markets.

The Democrats, who have promised to reduce bureaucrats' grip on policy, reorient spending towards consumers, and steer a diplomatic course less dependent on ally Washington, have a huge majority in parliament's powerful lower house.

But they need to win outright control of the upper chamber to reduce dependence on two small coalition parties that often take different stances on economic and foreign policies.
A loss by the ruling bloc would create a potential policy deadlock, since the upper chamber can delay legislation.

Ozawa has presented the Democrats with a dilemma ever since his small Liberal Party merged with them in 2003, since they rely on his skills even as his image puts their popularity at risk.

But many analysts say the main opposition Liberal Democratic Party, periodically racked by scandals during lengthy rule, may not benefit much from a fall in support for the government.

Instead, voters may opt for smaller groups of lawmakers who have already left or are considering breaking off from the LDP.

At this point, it's unclear the LDP is going to be the beneficiary, said Sophia University professor Koichi Nakano.

The biggest damage done is to Japanese democracy, its credibility, right at the time when the alternation in power happened.

Japanese media say prosecutors are probing the source of funds improperly reported by Ozawa's funding group, and suspect construction firms seeking government contracts were involved.

A protege of former LDP kingpin Kakuei Tanaka, considered by many the father of Japan's modern pork-barrel politics, Ozawa left the party in 1993 and has spent the years since working to oust his ex-colleagues.

He took over as Democratic Party leader in 2006 but stepped down last May after a former aide was charged with accepting illegal corporate donations.
(Writing by Linda Sieg; Editing by Jeremy Laurence)

Japan