ANALYSIS - Japan PM out of the frying pan, now into the fire

Japanese Prime Minister-elect Yukio Hatoyama makes an opening speech at Asahi World Environment Forum 2009 in Tokyo September 7, 2009.

TOKYO (Reuters) - Japan's prime minister has survived a coalition scrap over fresh steps to prop up the economy but, with his popularity in decline, he faces tougher tests crafting next year's budget and resolving an airbase feud with Washington.

Yukio Hatoyama's government, which took office in September, agreed on Tuesday to spend 7.2 trillion yen ($81 billion) to avert a return to recession, adding an extra 100 billion yen as a concession to a coalition partner whose demand for 8 trillion had delayed a deal.

But with the dominant Democratic Party dependent on two small parties on the right and the left to enact laws smoothly and Hatoyama unclear about how he plans to resolve the dispute with key ally Washington, his policy headaches are far from over.

"This clears one hurdle, but this administration still needs to resolve other problems, such as the issue of the U.S. base in Okinawa," said Kazuhiko Saito, chief analyst at brokerage Fujitomi Co Ltd.

Voters' doubts about Hatoyama's leadership have already begun to erode his ratings, which slipped to 59 percent in a newspaper survey published on Monday. That is still high for a Japanese leader, but compares with initial highs of over 70 percent.

Graphic on Japan voter support: r.reuters.com/myv63g

Some analysts said the hassles were only to be expected given the need for a coalition.

But a failure to resolve the feud over the U.S. Marines' Futenma air base in southern Japan, or prolonged squabbling over the budget for the year from April -- which Hatoyama aims to draft by the year-end -- would almost certainly hurt his ratings.

Sagging support would threaten the Democrats' ability to win an outright majority in an election for parliament's upper house in mid-2010, forcing them either to keep the awkward coalition that is complicating policy decisions or seek other partners.

A loss in the upper chamber would revive a pre-election parliamentary deadlock and stymie policy implementation, although some analysts doubt the coalition will fare that badly, given voters' disdain for the recently defeated Liberal Democrats.

"If he keeps taking time (on Futenma), his position will weaken," said Professor Yasunori Sone at Tokyo's Keio University. "If this drags into next year, people will think they cannot entrust diplomacy to Hatoyama."

CORROSIVE IMPACT

Tokyo is under U.S. pressure to implement a 2006 plan to move Futenma air base to a less-crowded part of the island of Okinawa as part of an overhaul of the 47,000-strong U.S. force in Japan.

Hatoyama, who has vowed to steer a diplomatic stance less dependent on Washington, said before his party's August election victory that he favoured moving the base off Okinawa.

Now he is caught between the hopes of Okinawa residents that were fanned by his election campaign comments and a tough stance by his coalition partners on one hand, and an increasingly frustrated Washington on the other.

Last week the head of the small Social Democrats threatened to leave the ruling bloc if her views were ignored, prompting Hatoyama to indicate he might delay a decision until next year.

"As a politician, I have a sense of crisis that if we do not resolve this problem properly there could be a serious loss of mutual trust in U.S.-Japan relations," Foreign Minister Katsuya Okada told a news conference on Tuesday.

He added that he did not think the time was right to begin a broad alliance review agreed upon when U.S. President Barack Obama met Hatoyama last month.

Hatoyama wants to meet Obama at climate talks in Copenhagen next week, and on Tuesday said the government was firming up its stance, but he gave no details. Analysts warned a meeting could backfire if the premier failed to convey a clear proposal.

"The real concern is that the crisis over the base issue starts having a corrosive impact on a range of issues," said Daniel Sneider at Standford University's Shorenstein Asia-Pacific Research Center.

"The world's two biggest economies need to coordinate on financial and economic policies. They need to be able to sit down and talk."

Hatoyama also faces a bumpy road as his government struggles to craft next year's budget.

The government must balance campaign promises to put more money in the hands of consumers and pressure from coalition partners to spend more against the spectre of falling tax revenues and a bulging public debt already headed for 200 percent of GDP this year.

Cabinet ministers have asked for 95 trillion yen in spending for 2010/11, a figure Hatoyama wants reduced by 3 trillion.

But a waste-cutting task force failed to hit that target, while falling tax revenues due to a fragile economy make it hard to keep a pledge to hold new bond issuance below 44 trillion.

"What is important is whether they can properly craft next year's budget. If they can't do that and can't resolve Futenma, the damage (to Hatoyama) will be big," Sone said. "There are lots of things that must be cut and it's going to be tough."

(Additional reporting by Yoko Nishikawa and Tetsushi Kajimoto; Editing by John Chalmers)