INTERVIEW-UPDATE 1-Small Japan party wants big spending

* Small opposition ally wants massive spending, tax cuts

* Postal privatisation rethink in cards if opposition wins

* Ally sees Democratic Party on track to form government

TOKYO, June 22 - Japan should boost its slumping economy with a mix of big spending and tax cuts and the resulting increase in tax revenues will help fix tattered public finances, the No. 2 official of a small opposition party said.

Recent surveys show the main opposition Democratic Party of Japan (DPJ) and its allies have a good shot at taking power in an election that must be held by October and could well come sooner. That would end more than 50 years of almost unbroken rule by the business-friendly Liberal Democratic Party (LDP).

The Democrats would need support from the conservative People's New Party and the tiny Social Democratic Party even if they win a majority in parliament's lower house in order to control the less powerful upper chamber, which can delay bills.

"We need to aggressively expand demand, improve the situation for households ... expand personal consumption and thus address fiscal reform," People's New Party Secretary-General Hisaoki Kamei told Reuters in an interview on Monday.

The party has called for a five-year, 200 trillion yen ($2 trillion) stimulus plan including 150 trillion yen in public works spending and 50 trillion yen in tax cuts, and wants a rethink of plans to privatise the postal system, long a source of patronage for conservative politicians in rural areas.

Japan's outstanding public debt is already around 170 percent of GDP and financial market players are worried about both ruling and opposition parties' commitment to addressing the problem.

POSTAL PRIVATISATION REVAMP

The Democrats and the People's New Party agree on the need to revise postal privatisation plans and both want to keep the sales tax at the current 5 percent for the next four years, Kamei said.

But he added that it was unclear to what extent his party's demands for mammoth spending and tax cuts would be adopted by a DPJ-led administration.

The People's New Party was formed in 2005 by former LDP lawmakers who opposed then-prime minister Junichiro Koizumi's plan to privatise the postal system.

Koizumi led the LDP to a huge victory in an election that year that he pitched as a referendum on postal privatisation as a symbol of market-friendly reforms. Japan Post, a state-owned holding company, is supposed to sell its stakes in two of its four units, one for banking and one for insurance, by 2017.

"We have agreed (with the DPJ) that the share sales should be frozen ... and if there is a change in government, we would speedily submit a bill to freeze the share sales," Kamei said.

Kamei, whose party now has five members in the 480-seat lower house, said the Democrats were on track to become the biggest party in the chamber and could well win a majority on their own.

Whether the People's New Party formally joined a coalition with the Democrats or supported a new government from outside the cabinet would depend on the extent to which its policies were taken on board, Kamei said.

But he ruled out the possibility of tying up with former colleagues in the LDP, no matter how the election turned out.

"We are not considering that at all," Kamei said.