(REUTERS) -- German steelmaker ThyssenKrupp and Finland's Outokumpu are in talks over a possible merger of their stainless steel businesses in a long-expected consolidation in a sector struggling with the economic downturn.

ThyssenKrupp, whose business stretches from submarines to lifts and car components, is looking to sell non-core assets with revenues of 10 billion euros ($12.7 billion) to help repay debts, which stood at 3.6 billion euros as of end September.

The tough market for stainless steel, used in everything from cutlery to rail cars, has prompted major steelmakers to reconsider their involvement in an industry that is battling with competition from Asia, overcapacity and the consequences of an economic downturn.

Giant ArcelorMittal spun off its Aperam unit through an IPO last year.

Outokumpu said it was holding preliminary discussions with ThyssenKrupp to evaluate potential strategic options, including a potential business combination with Inoxum, the stainless steel unit of ThyssenKrupp.

These discussions are ongoing and there can be no assurance that any transaction will be proposed or consummated, and if so, what the parameters of such transaction might be, Outokumpu said.

Outokumpu Chief Executive Mika Seitovirta told Reuters in November the European stainless steel industry needs consolidation and capacity cuts to cope with lack of big orders, lower prices and imports from Asia.

He said at the time that Outokumpu would want to be in the driver's seat of such consolidation.

A spokesman for ThyssenKrupp, Germany's biggest steelmaker, confirmed an earlier German newspaper report that it was in talks with its Finnish rival.

Two people close to the talks told Reuters ThyssenKrupp was aiming for a complete sale of its stainless steel unit, but no decision has been made yet.

Analysts value Inoxum at between 1 billion and 2 billion euros, with some excluding German operations because of ongoing restructuring there.

ThyssenKrupp has been in talks with Outokumpu for some time already, one of the people said.

The company's supervisory board still needed to approve a sale, the sources said.

Outokumpu shares were up 10.92 percent at 7.47 euros at 0950 GMT, while ThyssenKrupp was virtually flat at 21.7 euros.

Analysts have said previously that any deal with a rival would have to address the issue of plant closures to solve overcapacity in the region.

A merger would be good, because there is overcapacity in Europe, so some capacity could possibly be closed down, FIM analyst Martin Sundman said on Monday. Both parties would benefit from it.

ThyssenKrupp has so far said it aimed to divest the stainless steel business by around the end of 2012 and was considering either a flotation, a sale or a spin-off.

The Inoxum unit posted sales of around 5.9 billion euros in the 2009/10 fiscal year. It comprises plants in Germany, Italy, Mexico, China and the United States employing around 11,300 people.

ThyssenKrupp last year mandated Citigroup , Deutsche Bank and Rothschild to explore options for the unit.

($1 = 0.7740 euros)

(Additional reporting by Alexander Huebner in Frankfurt and Jussi Rosendahl and Terhi Kinnunen in Helsinki; Writing by Maria Sheahan; Editing by Mark Potter and Hans-Juergen Peters)