Japan and Australia are leaning towards a multibillion-dollar sale by Tokyo of a fleet of stealth submarines to Canberra's military in a move that could rile an increasingly assertive China, sources familiar with the talks said.
An agreement is still some months away, three people said, but the unprecedented sale of off-the-shelf vessels based on the Japanese Maritime Self-Defence Force's Soryu class sub is emerging as the likeliest option.
Such a deal would signal a major expansion of Japanese Prime Minister Shinzo Abe's controversial drive for a more active military after decades of pacifism. Rival China regularly accuses Abe of reviving Japan's wartime militarism.
Australia is eager to get the quiet diesel subs from Japan, despite the political backlash that would follow from abandoning a government pledge to build the vessels at home, said a person with knowledge of Canberra's thinking.
"It is the best option out there," said the source.
Abe and his Australian counterpart, Tony Abbott, agreed in July to "enhance our security and defence cooperation", including the transfer of military equipment and technology.
Discussions have since moved rapidly from engine-technology transfer to a full build in Japan, with the goal of replacing by the 2030s Australia's six outdated Collins-class boats with 12 scaled-down versions of the 4,000-tonne Soryu, the world's biggest non-nuclear sub.
"Discussions between Japan and Australia are gathering pace," one source said.
For Abe a deal, which could come as soon as January, would send a strong signal that Japan will be less constrained by its pacifist constitution.
He has already this year loosened curbs on arms exports, ended a ban on defending friendly nations and reversed a decade of military-spending cuts. Selling a fleet of subs would mark the first time since at least the end of the second world war that Japan had sold a complete weapons platform overseas.
Bulk orders for Japanese arms makers would help to bring down weapons-procurement costs for Tokyo, which has the biggest debt burden in the industrial world.
For Canberra, the sale would avoid the costs and risks of developing a homegrown champion from scratch, after the locally made Collins-class subs were panned for being noisy and easily detected.
A visit last week by representatives of the two Japanese companies to the Adelaide shipyards of government-owned ASC sparked fierce media speculation in Australia.
Japanese defence ministry spokesman Hirofumi Takeda declined to comment, saying only that "Japan and Australia are conducting various exchanges of opinion, including on equipment and technology transfer, as we move toward strengthening bilateral defence cooperation".
Australia acknowledged in July for the first time it might allow the subs to be built overseas.
Cost is an issue for Canberra. Defence minister Johnston told Reuters in June that he was "very disturbed" by the A$40 billion (HK$290 billion) estimate for the homegrown option.
Twelve top-of-the-line Soryu subs plus maintenance and overhaul would work out cheaper for Australia.