By Yoko Nishikawa
Aug 31 (Reuters) - Japan's opposition Democratic Party faces a raft of challenges after crushing the ruling coalition in an election on Sunday, including growing social welfare costs in a rapidly ageing society and tattered public finances.
The victory ends more than 50 years of almost unbroken rule by Prime Minister Taro Aso's conservative Liberal Democratic Party and will likely resolve a policy deadlock caused by a divided parliament, where the opposition controls the upper house and has delayed bills.
Following are major challenges for the new government.
ECONOMY
Japan's economy returned to growth in the April-June quarter, pulling out of its longest recession since World War Two. But the nascent recovery was due to short-term stimulus efforts and economists say it could lose momentum late this year.
Aso's government had planned 27 trillion yen ($288 billion) in stimulus spending since the global financial crisis erupted last year. The Democrats have said the government is spending money on the wrong things, such as a museum of Japanese pop culture, adding that it would cut wasteful spending from an extra budget for the year to next March after taking power.
But stimulus efforts from past economic problems have left a mountain of public debt equivalent to around 170 percent of GDP, the highest among advanced nations, worrying financial markets about further debt issuance.
The Bank of Japan, with its key policy rate near zero percent, last month extended by three months the September deadline for its unconventional measures aimed at easing corporate funding strains. The focus now is on when the central bank will exit from those emergency measures.
AGEING POPULATION, SALES TAX DEBATE
One of Japan's biggest challenges is to revamp and pay for soaring health, social welfare and pension bills as a wave of post-war baby boomers retire.
Economists say funding these will mean raising the nation's 5 percent consumption tax, but the topic is politically touchy.
The Democrats say they will not raise the tax at least for four years.
REFORM BACKLASH
Critics say five years of pro-market reforms under Junichiro Koizumi, prime minister from 2001 to 2006, have widened social, income and regional gaps, and both the LDP and the Democrats have sought to distance themselves from those changes, which included postal privatisation, deregulation of the job market, and repairing the nation's tattered finances.
The global recession intensified such criticism and has given some impetus to calls for a return to stronger regulation. Companies worry that trend will be stronger under a Democratic Party government, given the party's support among labour unions.
FOREIGN RELATIONS
Japan's new leader must address the challenge of China's rising regional clout, while keeping ties with its huge Asian neighbour and biggest trading partner on an even keel.
Sino-Japanese relations have improved recently after years of friction over Japan's military aggression in Asia before and during World War Two, but territorial and maritime disputes still simmer along with mutual mistrust over military ambitions. ($1=93.64 Yen)