By JOSEPH COLEMAN - Associated Press Writer

Saturday, July 20, 1996 2:44 am EDT

TOKYO (AP) -- China's growing military might including its nuclear capability and increasingly assertive navy is Japan's major defense worry, not troops in the Russian Far East, according to a government report.

The annual Defense Agency report released Friday said Japan should "keep a close eye on" China's military spending and exercises and its trend toward obtaining higher quality weapons.

"China's moves in developing nuclear capabilities and modernizing its naval and air forces, as well as expanding its activities on the seas ... need to be closely watched," the report said.

At the same time, the threat posed by troops stationed in the Russian Far East is diminishing, the Defense Agency said, no longer referring to the soldiers as a "destabilizing factor" as it had in previous reports.

The report also reiterated the importance of the U.S. military in maintaining peace and stability in Asia. It sidestepped the furor over the American military presence in the southern island of Okinawa, where opposition to the U.S. bases exploded after three servicemen raped a schoolgirl there last year.

Despite reports of famine and economic problems, North Korea is spending 20 to 25 percent of its gross domestic product on the military, the report said. Five percent of its 22 million people are in active military service, it said.

However, it was clear that China has moved center-stage in Japanese defense planners' minds.

The paper said China's reported military spending has grown by more than 10 percent in each of the last eight years and by around 11 percent for the current year, representing 9 percent of total budget outlays.

Those figures do not include money China spends on military research and development or weapons exports earnings that are recycled into the defense industry which Beijing does not report as military spending, the report said.

Japan's refocusing of its defense concerns follows several months of heightened tensions surrounding China's more aggressive military posture, including exercises and missile firings near Taiwan and its insistence on continuing nuclear tests.

China and Japan are also caught up in a territorial dispute over the Senkaku Islands known as the Diaoyu Islands in Chinese about 250 miles southwest of Okinawa and the same distance from China.

The paper also pointed to the need for Japan to slim down its Self Defense Forces with a plan to cut personnel to 145,000 from the current 180,000, filling part of the void with a 15,000-strong rapid reaction force.

The Japanese government report also showed a new willingness to live up to the security declaration signed with the United States in April committing Tokyo to consider ways its limited defense forces might operate outside national borders.

However, the report did not spell out any specific steps. The question of how far Tokyo should go in relaxing military restraints in its U.S.-written constitution is sensitive in Japan and other Asian nations.