Whoever becomes prime minister of Japan next week after Shinzo Abe's shock resignation will inherit an unpopular administration and face pressure to boost rural spending to revive support, despite high government debt.

Japan's economy has been growing steadily over the past six years but it contracted slightly in the April-June quarter and faces problems in the years ahead from an ageing population and growing competition in world trade.

Analysts see no big difference in economic thinking between frontrunner Yasuo Fukuda and Taro Aso in the race to lead the ruling Liberal Democratic Party, and hence the country, and their focus on rural issues has raised fears about budget discipline.

"They see the need for steps to win back votes in the rural areas after election defeat, while calling for continued efforts to push forward reforms and fiscal consolidation," said Masaaki Kanno, chief economist at JPMorgan Securities Japan.

"So they have been inarticulate in offering specific economic policy proposals and they lack a clear message on what they want to do, raising concerns among foreign investors that Japan may backtrack on its pro-reform agenda."

Opposition parties that have controlled parliament's upper house since July -- giving them power to block government policy -- have called for more public spending, as have rural members of the LDP, whose areas have suffered under recent reforms.

Economists fear that proposals to increase the 5 percent consumption tax will be an early casualty of the leadership change after Sunday's party election, especially with the economy hitting a soft patch.

But analysts say Japan's mountain of public debt -- equivalent to one-and-a-half times GDP -- means the government can no longer afford to fall back on construction spending, often on politically motivated projects, to boost the economy.


Both Fukuda and Aso are well aware of the fiscal pressure, but economists wonder if politics will trump economics, especially given the risk that deadlock in parliament could easily lead to a snap election.

The fear is that the policy debate will be stalled for months or even years, at a time when the government has to work out how to pay the welfare bill as baby boomers start to retire in waves.

"There is no time to waste as the economy seems to be at a critical stage," said Hisashi Yamada, the head of Japan Research Institute's business strategy research centre.

The government had been due to start discussing tax reforms later this year, including the unpopular rise in the consumption tax, but many expect the debate to be postponed.

Both Fukuda and Aso have spoken of the need to consider such a tax increase but have carefully avoided suggesting when it should happen or by how much it might go up.

On Wednesday, the New Komeito party, the junior partner in the ruling coalition, suggested delaying the government's goal of moving the government's annual budget, excluding debt costs, back into surplus by 2011/12.

"Many expect a new cabinet will be short-lived, so any fully fledged policy debate will only come after a snap election," said Yasuhiro Onakado, chief economist at Daiwa SB Investments.

"Worries about a delay in fiscal consolidation efforts could heighten, so the key for the new cabinet is whether it could prevent such calls and make sure next year's budget shows fiscal tightening."

A general election is not required until late 2009 but many doubt the government can hold out that long in the face of a resurgent opposition.

Japan's economy is unlikely to give the government much room for maneuver on the fiscal front.

While growth is expected to recover from the second quarter contraction, the picture has been muddied by financial market turbulence sparked by the mortgage crisis in the United States, Japan's biggest export market.

One thing economists will be looking out for is how the new prime minister handles the Council on Economic and Fiscal Policy, the forum that Junichiro Koizumi, Abe's predecessor, successfully used to thrash out and promote reforms.

They are intrigued to see whether he will use the body, made up of economic ministers and private sector experts, to promote a hands-on approach to economic policy or let government and party bureaucrats set the agenda to push their own interests.