Haggling over powerbroker Ozawa plagues Japan's DPJ (Reuters)

Japan's ruling Democratic Party (DPJ) avoided a bust-up over scandal-tainted powerbroker Ichiro Ozawa on Monday, but internal bickering looked set to plague the government as it struggles to finalize next year's budget.

The haggling over whether Ozawa should appear before a parliamentary ethics panel over a funding scandal has distracted from policy decisions as the government seeks ways to pass bills in a divided parliament and bolster a weak economy.

Katsuya Okada, the DPJ's secretary general, told a news conference that party executives had entrusted him with a decision on the matter and that he would try to meet Ozawa soon to urge him to appear before the parliamentary panel.

"The issue is one of the reasons obstructing the operation of parliament and ... could affect elections," Okada said.

He added that if Ozawa refused to appear voluntarily, he would decide the party's stance, but sidestepped questions about what would happen if Ozawa did not explain himself in parliament.

The DPJ swept to power last year, ending more than half a century of almost non-stop rule by its conservative rival.

But the scandal dogging Ozawa, a veteran strategist, has helped to slice voter support for Prime Minister Naoto Kan's government to about 25 percent.

"The problem at the moment is that we've got a lot of huge problems in Japan and they are just not being dealt with," said Nicholas Smith, director of equity research at MF Global FXA Securities in Tokyo. "Foreigners are watching this very closely."

Party strife, he said, would affect a wide range of policies from a possible future rise in the 5 percent sales tax to fix Japan's debt-laden public finances to passage of the state budget from next April 1 and a proposed cut in corporate income tax.

A judicial panel has ruled that Ozawa, 68, must be indicted on suspicion on falsification of reports by his political funding organization.

He has denied any wrongdoing and could well refuse to appear before the ethics panel, which has no authority to force him to attend.

DISMAL ELECTION SHOWING

Okada may hope that sending a signal about the need for Ozawa to explain himself might help to win support in parliament from the second-biggest opposition party, the New Komeito.

The rift has fanned concerns that Ozawa might leave the DPJ as he did in 1993 from the Liberal Democratic Party, sparking a chain reaction that briefly pushed the party from power.

But analysts said that Ozawa, whose clout appears to be waning, might be wary of defecting this time. "I think things will go on this way for a while," said Katsuhiko Nakamura, executive director at the Asian Forum Japan think tank.

The turmoil coincides with efforts to wrap up the draft 2011/12 budget by Christmas. But some bond market players said the confusion was unlikely to directly affect efforts to balance spending to bolster the stalling economy with the need to curb public debt already twice the size of the $5 trillion economy.

A dismal showing by Democratic candidates in a local assembly election on Sunday in Ibaraki, north of Tokyo, was likely to add fuel to the internal battle in the party, a mixed bag of former LDP lawmakers, ex-socialists and younger conservatives.

Kan led the DPJ to defeat in a July upper house poll a month after taking office and worries about a poor performance in local elections in April could lead to calls to replace him.

A former grassroots activist, Kan is already Japan's fifth leader in three years.

Ozawa lost a leadership challenge to Kan in September and analysts say many of his followers might be reluctant to follow him out of the party given his waning clout.

He stepped down as DPJ leader over the funding scandal ahead of the August 2009 general election that propelled the party to power with promises to change how Japan is governed.

Ozawa was then appointed to the DPJ's No. 2 post of secretary-general by then-Prime Minister Yukio Hatoyama, but resigned that position when Hatoyama, his own ratings in tatters, abruptly quit in June.

(Additional reporting by Kiyoshi Takenaka, Nathan Layne, Chikafumi Hodo, Shinichi Saoshiro and Rie Ishiguro; Editing by Ron Popeski and Joseph Radford)