FILE PHOTO: Pedestrians walk past the Bank of Japan building in Tokyo, Japan March 18, 2024. REUTERS/Kim Kyung-Hoon/File photo

By Takaya Yamaguchi and Leika Kihara

TOKYO (Reuters) -Japan's government spending requests for next fiscal year will likely set a record for the third consecutive year, a draft of the requests obtained by Reuters showed on Monday, highlighting the challenge the country faces in fixing its dire finances.

The expected rise in spending comes on top of calls for tax cuts by opposition parties, which Prime Minister Shigeru Ishiba's minority coalition must heed to pass next year's budget through parliament.

Under next fiscal year's budget, government agencies will request a combined 122.45 trillion yen ($831.13 billion) in spending, the draft of the requests showed.

The biggest outlay would come from the health ministry, which requested 34.8 trillion yen in spending mostly to pay for rising social welfare costs for an ageing population.

A record 32.4 trillion yen would be requested for servicing Japan's huge debt, as the central bank's interest rate hikes and rising bond yields push up the cost of borrowing.

Requests for defence spending are also set to rise to a record 8.8 trillion yen, the draft showed.

The Ministry of Finance (MOF) will scrutinise the requests to finalise the government's fiscal 2026 draft budget by the end of this year, which will then be submitted to parliament for deliberation.

Bond yields have risen recently as investors focus on how Ishiba's fragile political standing could affect Japan's efforts to rein in a debt pile which, at twice the size of its economy, is the biggest among its major peers.

Known as a fiscal hawk, Ishiba has faced calls from within his party to step down to take responsibility for a stinging upper house election loss in July.

Ishiba's administration will face its biggest test when his ruling Liberal Democratic Party (LDP) will decide on September 8 whether to hold a race to choose a new party leader.

"Ishiba, who emphasises fiscal discipline, has seen approval ratings rise," said Takahiro Otsuka, senior fixed income strategist at Mitsubishi UFJ Morgan Stanley Securities. "But considering the upcoming political calendar, markets haven't dispelled concern over the risk of further fiscal expansion."

The Nikkei newspaper reported on Friday that spending requests under the fiscal 2026 budget will exceed 122 trillion yen.

($1 = 147.3300 yen)

(Reporting by Takaya Yamaguchi; Writing by Leika Kihara; Editing by Christopher Cushing and Sam Holmes)