Japan will pledge to cap new bond issuance next fiscal year at the record sum earmarked for this year, National Strategy Minister Satoshi Arai said, as the new government struggles to convince markets of its resolve to fix the country's tattered finances.

Arai told reporters on Friday the government will finalize a long-term fiscal strategy framework by June 22, just days before a summit of G20 leaders in Toronto, as Tokyo aims to rein in a public debt nearly twice the size of Japan's GDP.

New Japanese Prime Minister Naoto Kan is due to unveil this month a strategy consisting of both medium- and long-term targets as investors fret about sovereign credit risk.

The Nikkei newspaper reported on Friday that the fiscal framework will include a pledge to cap budget spending for three years and bring the primary balance -- the net figure for government borrowing and lending -- into the black by March 2021.

But Finance Minister Yoshihiko Noda said that the report was clearly wrong and that the government was still putting the finishing touches on its framework for fiscal reform.

The National Strategy Bureau is at the center of government efforts on the fiscal framework and we are in the final stages of compiling the plan, Noda told reporters after a cabinet meeting on Friday.

Rating agencies have warned they could cut Japan's sovereign debt rating unless it produced a credible plan to rein in debt.

Japanese sovereign CDS are trading at their widest in 15 months near 100 basis points, with outstanding volume near record highs, as market players brace for problems in the years ahead.

Ideally, the plan should be grounded in a broader economic policy framework including pro-growth structural reforms and clarity on the monetary policy objective, said Andrew Colquhoun, director of Fitch's Sovereigns Ratings Team.

Our view is that Japan's ratings will come under downwards pressure in the medium term unless the public finances get on a sustainable footing, he told Reuters.

Arai, who is directly in charge of crafting the fiscal framework, said the government will aim to cap new bond issuance for next fiscal year at the 44.3 trillion yen ($484.6 billion) earmarked for this year, as part of the fiscal framework.

Japan has earmarked 53.5 trillion yen in spending for this fiscal year ending in March 2011. The government will pledge to cap budget spending to that amount for three years until March 2014, the Nikkei said.

With tax revenues unlikely to rise much after being hit by a weak economy, achieving such a target may be tough unless the ruling Democratic Party reconsiders some of its generous spending plans promised in its campaign pledge.

That is more so if Kan sticks to his pledge, made when he was finance minister, to cap new government bond issuance at 44.3 trillion yen next fiscal year.

In its new campaign pledge for the July upper house election, the Democrats will mention the need to keep new bond issuance at or below 44.3 trillion yen in the year to March 2012, the Asahi newspaper said on Friday.

The manifesto will also say the party will set up a bipartisan panel to discuss tax reforms, including the sales tax, the Asahi said.

Many analysts say Japan would have to consider raising the sales tax from the current 5 percent as a rapidly aging population pushes up social security costs.

Japan's economy grew 1.2 percent in January-March from the previous quarter, the fastest growth in three quarters, on robust exports to fast-growing emerging Asian markets.

The government may raise its economic growth forecast for the current fiscal year to above 2 percent and below 3 percent, from an earlier estimate of 1.4 percent, according to the Nikkei.

That may give Kan some momentum to move toward fiscal austerity, although time constraints mean no policy action is expected until after the upper house election in July.

Banking minister Shizuka Kamei, who heads a small party in the ruling coalition and has called for big fiscal spending, said on Friday he would leave the cabinet, which some analysts say may make it easier for Kan to pursue fiscal reforms.

Japan's sovereign five-year credit default spread has widened to just below 100 basis points this week. It was indicated at 92-92 basis points on Friday, slightly down from 97-98 basis points on Thursday.

The main factor that has caused a widening in Japan's sovereign CDS spread is coming from elsewhere, not from Japan, said a CDS trader at a brokerage in Tokyo, adding that overseas players were buying protection for government debt on jitters about Europe's debt problems.

At the same time, it is also true that the spread of Japan's sovereign CDS looks tight compared to those of other countries, given Japan's high ratio of public debt against GDP.

(Additional reporting by Stanley White, Kaori Kaneko, Charlotte Cooper and Rika Otsuka; Editing by Hugh Lawson)

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