UPDATE 2-IHI, A123 Systems ally in lithium-ion batteries

* IHI to sell A123’s low-cost batteries in Japan in 2010

* Batteries will be used for electric, hybrid cars, ships

* IHI shares fall 1.1 pct vs 1.4 pct drop in the Nikkei (Adds details after announcement)

TOKYO, Oct 28 (Reuters) - Japan's IHI Corp 7013.T said on Wednesday it would start selling low-cost lithium ion batteries developed by U.S. company A123 Systems Inc AONE.O in Japan in 2010, as it looks to tap surging demand from electric vehicle producers and other manufacturers.

Government subsidies have boosted appetite for environmentally friendly cars in the country since they were launched in June.

IHI, a heavy machinery maker, said the batteries made by A123 are more cost competitive than rivals’ because they do not use rare earth as a raw material.

The company plans to sell the batteries to carmakers, include them in its power supply systems and use them in ships, an IHI spokesman said.

A123 develops batteries for electric vehicles and plug-in hybrids and works with carmakers such as BMW BMWG.DE, Chrysler Group LLC and General Motors [GM.UL].

Its shares jumped 50 percent on the day it debuted on the Nasdaq stock market last month.

Lithium-ion batteries are a hot area of investment for many Japanese companies.

Sanyo 6764.T, the world's largest maker of rechargeable batteries and set to be taken over by Panasonic 6752.T, is developing lithium-ion batteries for cars with Volkswagen AG.

Toshiba Corp 6502.T said on Tuesday that it would invest 25 billion yen ($273.7 million) to build a new lithium-ion battery plant in Japan. [ID: nT322473]

Mitsubishi Heavy Industries Ltd 7011.T also plans to spend 10 billion yen to build a test plant for the production of lithium-ion batteries. [ID:nTKB006387].

Nissan Motor Co 7201.T expects to start selling electric vehicles in Japan and the United States in 2010 and to start fully-fledged sales globally by the 2012 financial year.

IHI's shares closed down 1.1 percent at 179 yen, outperforming a 1.4 percent decline in the benchmark Nikkei average .N225. (Reporting by Yuko Inoue, Nobuhiro Kubo, Mariko Katsumura; Editing by Joseph Radford)