Domestic car sales are weak, but Japan's big automakers such as Toyota and Honda plan to build new factories and increase output to feed a growing export trade to the Middle East and other smaller markets.

Not so long ago, government officials and economists fretted that car manufacturing in Japan could be hollowed out as China lured assemblers with cheap labor and explosive sales growth.

But companies such as Toyota Motor Corp and Honda Motor Co were surprised by a jump in demand in North America and Europe, forcing their factories in Japan to crank up output past standard capacity.

Now, with sales surging in emerging markets from Russia to South America, carmakers are shifting gear again.

Toyota, Honda, Suzuki Motor Corp, Mazda Motor Corp, Daihatsu Motor Co and Fuji Heavy Industries Ltd will all step up production in Japan in the next few years. Honda and Suzuki will build their first domestic plants in 30 years.

Five years ago, no one would have dreamed that in a span of 2-3 years, four new factories would be built in Japan, said Koji Endo, auto analyst at Credit Suisse.

The mantra from Japanese automakers used to be: 'We're going to build cars where they are sold.' Now they're saying: 'We need exports too.' It's a complete about-face.

In the past year, a fall in the yen provided a big bonus for Japanese automakers. But currency rates have little to do with the decision to build more cars in Japan, auto executives say, as long as the dollar doesn't fall back down below 100-105 yen.

JP Morgan auto analyst Takaki Nakanishi last month raised his forecasts for domestic auto production by 50,000 vehicles to 11.75 million in the year to end-March 2008, and by 150,000 vehicles to 12.256 million in fiscal 2009/10.

In calendar 2006, production hit 11.48 million, rising for a fifth straight year and nudging Japan past the United States as the world's biggest vehicle producer. Just over half the vehicles were exported.

Ultimately, when you look at manufacturing efficiencies, flexibility, cost competitiveness, speed, quality and so many other factors, it makes sense to invest in Japan, Nakanishi said.

If he's right, economists -- many of whom expect annual production to hover around 10-11 million vehicles -- could be in for a pleasant surprise, especially after the government recently announced a bleaker outlook on personal spending.

The ripple effect of added production in an industry that buys thousands of parts including semiconductors, batteries, and electronics products, would be significant.

TOYOTA LEADS CHARGE

Auto executives play down the strengthening trend for domestic production since rising exports have traditionally touched a political nerve with the United States.

Last year's 34 percent jump in exports to North America raised eyebrows, but that number is set to fall this year as Japanese carmakers increased U.S. production.

However, in the Middle East, there is virtually no supporting industry and it is content to import cars.

Many of those will come from Toyota, which expects its Middle East sales to climb 30 percent to 560,000 vehicles this business year. To help meet that demand, Toyota's domestic plants are building cars at a pace of at least 4.2 million this year, against official capacity of 3.8 million.

The trajectory suggests our (parent-only) sales will grow to 9, 10 million vehicles (from 7.92 million last year), Toyota Executive Vice President Mitsuo Kinoshita said recently.

Part of the added volume is going to be supplied by Japan, so we need to think about beefing up our domestic operations.

About one-third of Toyota's cars sold overseas are supplied from Japan, and that ratio will likely stay the same, he said.

That means, in very simple terms, if we add 1 million cars in overseas sales, we'd need capacity for 300,000 vehicles in Japan, Kinoshita said, noting that lumping together production for vehicles bound for low-volume markets was more efficient than building them in those markets.

MODEL OF EFFICIENCY

Carmakers' efforts to hone their manufacturing efficiencies and build more advanced cars are another reason behind the renewed production push in Japan.

Nissan Motor Co's 2009 remodeled Murano SUV, destined first for North American markets, will be made here on the southern Japanese island of Kyushu.

Nissan has great confidence in its Kyushu plant, Chief Executive Carlos Ghosn said at a Murano launch ceremony on Friday. That's why we will build many of our key future products here.

At a groundbreaking ceremony for Honda's planned new factory in September, Chief Executive Takeo Fukui said state-of-the-art facilities were crucial to building more fuel-efficient and value-added cars, as well as improving production efficiencies by becoming more flexible.

Honda builds all its hybrid cars at home due to their complexity, for instance, just as Toyota does with most of its tech-packed Lexus cars. That, Fukui said, made sense even if the dollar fell to 105 yen and made exporting more costly.

That's also good news for Japan.

Japanese automakers are clearly poised to build more high-margin cars at home, and that's going to add more value, said Yoshimasa Maruyama, economist at BNP Paribas.

Japan's economy is going to be overtaken one day by China and India in size, but with this trend it will continue to lead in wealth per capita.

(Additional reporting by Noriyuki Hirata; Editing by Lincoln Feast & Ian Geoghegan)

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