After nearly two years of preparatory talks, Japan and Vietnam are expected to launch full-scale negotiations early next year on an investment protection pact to encourage Japanese companies to invest in the potentially lucrative, communist-ruled Southeast Asian market.

Government sources said Thursday that Japan will compile a draft pact between the two countries as early as next month through consultations among its trade, finance, foreign and other government ministries and agencies.

The Japanese draft will serve as a basis for full-scale negotiations on the bilateral pact, which would, among other things, enshrine the principle of granting most-favored-nation status to Japanese investors in Vietnam. Under the MFN status, Japanese investors would receive equal treatment with their foreign counterparts.

The investment protection pact would also compensate Japanese investors for possible losses incurred from civil strife, confiscation of their assets and other emergencies in Vietnam. Under the pact, Japanese investors in Vietnam might be guaranteed "national treatment" -- or equal treatment with their local counterparts -- in some sectors.

If full-scale negotiations go smoothly, a final agreement on the protection pact could be reached by summer, the sources said. Japan has so far concluded investment protection pacts with several countries, including China, Sri Lanka, Bangladesh, Russia, Egypt and Turkey.

Although then-Prime Minister Keizo Obuchi and his Vietnamese counterpart, Phan Van Khai, agreed at a Tokyo meeting in March 1999 to initiate negotiations on the investment protection pact, the negotiations have so far been limited to preliminary talks not based on a draft pact.

Phan Van Khai, who took office in September 1997, was making the first official visit to Tokyo by a Vietnamese leader in six years. His predecessor, Vo Van Kiet, visited Tokyo in the spring of 1993, only several months after Japan became the first major industrialized country to resume full-scale economic aid to the impoverished country. Japan is by far Vietnam's largest single aid donor.

During Phan Van Khai's Tokyo visit, Japan granted MFN status to Vietnamese exporters to its market. As a result, they now face the lowest possible Japanese import-tariff rates granted to developing countries.

Hanoi had initially wanted to have the Japan-Vietnam investment protection pact signed by the end of this year, but the launch of full-scale negotiations were delayed, partly because of the signing in July of a landmark trade agreement between Vietnam and the United States.

The sources said that Japan aims to get similar investment protection measures to those gained by the U.S. However, Japan will not get tough in the negotiations, given the fact that Vietnam is still not a member of the World Trade Organization, the sources added.

The Vietnam-U.S. trade agreement, which was signed after four years of negotiations, will improve investment relations between the two countries as well as reduce tariffs on goods and services and protect intellectual property.

Twenty-five years after the end of the Vietnam War, U.S. President Bill Clinton made a historic visit to Vietnam last month, completing the normalization process that began in July 1995, when the two countries established diplomatic ties.

The signing of the Vietnam-U.S. trade agreement gave a boost to the Asian nation's bid for WTO membership, although Vietnam's actual entry into the Geneva-based watchdog over international commerce may be at least several years off.

Vietnam embarked on free-market reforms in the late 1980s under the "doi moi" -- or "renovation" -- policy and joined the Association of Southeast Asian Nations in July 1995. Vietnam has a large population of about 80 million and is rich in such natural resources as oil and gas.

In the early 1990s, Vietnam saw the relatively smooth development of its economy, with its annual economic growth averaging 9 percent between 1993 and 1997. But the country was not spared the fallout from the 1997-1998 Asian financial and economic crisis. Its economic growth slowed down sharply due to slumping exports and declining foreign investment, especially from its Asian neighbors.

Japan lags behind Singapore, Taiwan and Hong Kong in terms of Vietnam-bound investment. The Japan-Vietnam investment protection pact alone may not be enough to lure more Japanese investors to Vietnam because, many analysts point out, Vietnam must still do much more to improve its foreign-investment climate, including the acceleration of free-market reforms and improvements in its cumbersome and time-consuming procedures for approving investments.