* Ruling parties officials agree to proposed change
* Cabinet resolution lifting ban of collective self-defence expected
* Japan public wary of loosening constitutional limits on military
* China media says Abe "dallying with spectre of war" (Updates with China media commentary par 4)
By Linda Sieg and Antoni Slodkowski
TOKYO, July 1 (Reuters) - Japan's cabinet was poised on Tuesday to end a ban that has kept the military from fighting abroad since World War Two, a major shift away from post-war pacifism and a victory for Prime Minister Shinzo Abe, but a move that will rile China.
The move, seen by some as the biggest shift in defense policy since Japan set up its post-war armed forces exactly 60 years ago, would end a ban on exercising "collective self-defense" or aiding a friendly country under attack.
It would also relax limits on activities in U.N.-led peace-keeping operations and "grey zone" incidents that fall short of full-scale war, according to a draft cabinet resolution.
"No matter how Abe glosses over it, he is dallying with the specter of war through a cheap scam but at the dear cost of the souls not only of his own but also of the entire Japanese nation," said an English language commentary by China's official Xinhua news agency.
Long constrained by the pacifist post-war constitution, Japan's armed forces will gain an expanded range of military options, although the government would likely remain wary of putting boots on the ground in multilateral operations such as the 2003 U.S.-led invasion of Iraq.
Abe has pushed for the change since taking office 18 months ago despite wariness among many Japanese voters worried about entanglement in foreign wars and angry at what some see as a gutting of the constitution's war-renouncing Article 9 by ignoring formal amendment procedures. The charter has never been revised since it was adopted after Japan's 1945 defeat.
Hundreds of protesters, including pensioners and labour union members, marched near the premier's office on Tuesday carrying banners and shouting, "Don't destroy Article 9" and "We're against war".
"I'm against the right of collective-self defence, but more importantly, I'm against the way Abe is pushing this change through," said 21-year-old university student Misa Machimura.
On Sunday, a man set himself on fire near a busy Tokyo intersection - a rare form of protest in Japan - after speaking out against Abe's re-interpretation of Article 9.
The change will also likely rile an increasingly assertive China, whose ties with Japan have frayed due to a maritime row, mistrust and the legacy of Japan's past military aggression.
It will, however, be welcomed by Washington which has long urged Tokyo to become a more equal partner in their alliance.
Officials in Abe's ruling coalition parties agreed on Tuesday morning to the proposed lifting of the ban on collective self-defense, paving the way for cabinet later in the day to adopt a resolution revising a long-standing interpretation of the U.S.-drafted constitution.
Legal revisions to implement the change must be approved by parliament and restrictions could be imposed in the process.
Since its defeat in 1945, Japan's military has not engaged in combat. While successive governments have stretched the limits of the pacifist charter to develop a military now on par with that of France and to permit non-combat missions abroad, its armed forces remain far more constrained legally than those of other nations.
Conservatives say the constitution's Article 9 has excessively restricted Japan's ability to defend itself and that a changing regional power balance, including a rising China, means Japan's security policies must be more flexible.
China, however, will likely argue Japan is raising regional tensions and support its case by pointing to Abe's efforts to cast Tokyo's wartime past with a less apologetic tone.
"It makes it easier for competitors to paint Japan as a wolf in sheep's clothing," said Richard Samuels, director of the Center for International Studies at the Massachusetts Institute of Technology. But he added: "Just because Japan is strong does not mean that it will be aggressive."
According to the latest draft cabinet resolution, Japan could exercise force to the minimum degree necessary in cases where a country with which it has close ties is attacked and the following conditions are met: there is a threat to the existence of the Japanese state, there is a clear danger that the people's right to life, liberty and the pursuit of happiness could be subverted, and there is no appropriate alternative.
Precisely how the change might work in practice remains unclear. Junior coalition partner New Komeito is stressing that the scope of revision is limited, and Japanese voters are still wary of entanglements in conflicts far from home. (Additional reporting by Nobuhiro Kubo and Kiyoshi Takenaka; Editing by Mark Bendeich, Dean Yates and Richard Pullin and Michael Perry)