Japan’s ruling party faced the prospect of political gridlock on Monday as bad losses in weekend parliamentary elections undermine its attempts to reduce the ballooning budget deficit and revive growth in the world’s second—largest economy.

Half the 242 seats in the upper house of parliament were up for grabs on Sunday. The ruling Democratic Party of Japan won only 44 seats, far below its stated goal of 54, while opposition parties made major gains.

That leaves the Democrats and their tiny coalition partner with 110 seats in the chamber, well below their majority of 122 before the vote. The conservative Liberal Democratic Party won 51 seats, bringing its total to 84.

Prime Minister Naoto Kan’s party will retain power because it still controls the more powerful lower house. But the results are a dramatic contrast to the Democrats’ landslide victory just a year ago, when they seized control of parliament and ended the rival Liberal Democrats nearly unbroken 55—year rule.

The Democrats didn’t appear to be reaching out to other parties on Monday to join their coalition and none showed an interest in coming on board. Mr. Kan said early Monday that the party might seek the cooperation of other parties on a policy—by—policy basis.

Without a majority in the upper house, the Democrats will find it difficult to move ahead on their agenda, which includes cutting wasteful spending, making government more open and creating a solid social security system as the population rapidly ages and shrinks.

In office just a month, Mr. Kan warned that Japan’s finances could face a Greece—like meltdown if it doesn’t cut back on soaring debt, twice the country’s GDP, and suggested raising the sales tax as a solution.

But voters, already suffering from the economic downturn, rejected that idea.

“The sudden announcement increased voter distrust towards Mr. Kan. No one is sure what he is going to come out with, and the feeling is that he may suddenly go back on past promises,” said Koichi Nakano, a political science professor at Sophia University in Tokyo.

Mr. Kan acknowledged defeat early Monday morning, saying he failed to fully explain his proposal to raise the sales tax from five percent to as much as 10 percent in coming years.

While many voters say a tax hike may be inevitable, they want a more detailed discussion first.

“If we look at the deficit, it’s reasonable to raise taxes to 10 percent, because we really have to revitalize the economy,” said Sadako Fukano, 71, a housewife in Tokyo. “However, the prime minister’s explanation as to where he’s going to spend the tax money wasn’t enough.”

While Japan’s public debt is serious, analysts say any comparison to Greece is an exaggeration, because most government bonds are held by domestic investors, who are unlikely to dump them.

Sunday’s results also underlined deep public disappointment over how the Democrats had gone back on their campaign promises. Chief among them was former Prime Minister Yukio Hatoyama’s failure to move a U.S. Marine base off the island of Okinawa, which along with a funding scandal chased him from office last month.

Mr. Kan, a former finance minister with roots in grass—roots activism, enjoyed support ratings of more than 60 percent when he took office in early June.

But that plunged after he proposed the tax hike. As the elections neared, Mr. Kan backtracked and promised there would be no tax increase until after the next lower house election, which must be held within three years.

The swing in public opinion has emboldened the opposition and raises the spectre of gridlock on key legislation such as the budget. Smaller parties quickly distanced themselves from the ruling Democrats on Monday.

“Even if there was an offer to form a coalition, we wouldn’t do so,” said lawmaker Yoshimi Watanabe, who heads the new Your Party, which won 10 seats.

Japan is deeply invested in worldwide markets, and slow growth here can have a significant impact on the global economy. Mr. Kan said his experience as finance minister made him keenly aware of the need to keep Japan’s economic engine running and not seek short—term fixes.

But now, Mr. Kan may struggle to achieve his policy goals.

“Because of political compromises ... ‘bold’ measures of either fiscal restoration or fiscal stimulus are unlikely to be taken, and the government measures are likely to be neutral or small for the economy,” Takuji Aida, an economist with UBS in Tokyo said in a note to clients.

Mr. Kan said he planned to keep his job and does not plan a major shake—up of the Cabinet, though he must defend his post in party polls in September. He vowed to press on with economic reforms even if they are not easy to stomach.

“I sincerely and humbly accept this result,” he said. “I will continue to push for responsible government.”

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