Renesas gave no details on the tie-up, which it plans to announce next Monday, although chipmakers are increasingly tapping the technological prowess of companies such as TSMC, the world's biggest contract chipmaker, to keep costs under control.

Renesas is already a client of both TSMC and rival United Microelectronics Corp, the No.2 contract chipmaker.

While a rising yen squeezes margins at its plants in Japan, Renesas, the world's biggest supplier of microcontroller chips for automobiles, is under constant pressure to spend heavily on a technological arms race with emerging overseas rivals to produce smaller and more powerful chips at lower prices.

High costs and fierce competition with the likes of Samsung Electronics had forced Elpida Memory, Japan's last player in dynamic random-access memory chips, into bankruptcy protection in February.

"People in the market are calling this the next Elpida, but I can't tell yet to what extent that might be true," said Tetsuro Ii, president of Commons Asset Management, which has $33 million of assets but holds no Renesas shares.

"What I hear from the industry side is that when Chinese and Taiwanese manufacturers decide to build new plants they do so quickly, and at huge cost, and start operating right away.

"But the Japanese industry doesn't have the capital to do anything like that."

TECHNOLOGICAL ARMS RACE

Renesas posted a 62.6 billion yen net loss in the financial year to March 31 after last year's natural disasters in Japan and Thailand forced it to shut eight factories and encouraged domestic automakers to diversify their supplies.

The company, formed by a merger of once-mighty chipmaking operations at conglomerates Hitachi Ltd, Mitsubishi Electric Corp and NEC Corp, has posted cumulative net losses of nearly $6 billion over seven consecutive years in the red.

Mitsubishi Electric's president said this week that his company and the two others were prepared to offer support to Renesas but that no discussions had yet taken place on financial assistance.

The Yomiuri newspaper reported on Tuesday that Renesas plans to raise 50 billion yen ($630 million) in new capital, while cutting its workforce by about 15 percent.

Typically in Japan, where layoffs remain taboo, companies reduce their workforce through voluntary redundancies or by shifting workers to affiliates' payrolls. An increasing number of Japanese companies also hire short-term contract workers who can be let go when their contracts come up for renewal.

In 2003, Japanese suppliers held a 27 percent supply of global semiconductor revenue, but falling prices and mounting competition from South Korea had slashed that to 19 percent by 2011, according to research firm IHS iSuppli.

Toshiba Corp, Japan's biggest chipmaker, has managed to remain competitive by focusing on NAND memory chips used extensively in smart phones and tablets.

With the Japanese chip industry in a state of flux, sources with knowledge of the matter told Reuters earlier in the year that Renesas, Fujitsu Ltd and Panasonic have also been in talks on combining their system chip operations with the financial backing of government-backed investment fund Innovation Network Corp.

The Yomiuri reported on Thursday that the Renesas tie-up with TSMC was likely to involve contracting out chip production to the Taiwanese firm.

"Renesas is not a major client of TSMC. I think this tie-up is just for Renesas to catch up on collaboration and to secure advanced technology," said Nomura Securities analyst Patrick Liao.

He said many chip vendors were looking to TSMC, which has been quicker than rival contract chip makers to make the expensive shift to narrower 28-nanometre circuitry in its chips.

"Comparing to its peers like Toshiba who has been very aggressive, Renesas is considered a late comer. Toshiba is not only working with TSMC on 28 nm but also with Samsung."

Renesas shares were up 1.9 percent at midday on Thursday at 268 yen, outperforming a 0.5 percent drop in Tokyo's Nikkei benchmark. The company's shares, however, have fallen by more than half since late March compared with a 15 percent drop in the Nikkei, as its business deteriorated.

($1 = 79.2300 Japanese yen)

(Additional reporting by Ayai Tomisawa in Tokyo and Clare Jim in Taiwan; Writing by Edmund Klamann; Editing by Eric Meijer)

• A Permanent Economic Emergency