Japan says it is willing to write off most of Iraq's debts, provided other major creditors do the same.
Some Japanese fear troops will be drawn into the Iraq conflict
The announcement came as US envoy James Baker held talks with Prime Minister Junichiro Koizumi, and follows similar pledges from several European nations.
Japan has already pledged $5bn in aid and will send about 1,000 troops to help reconstruction efforts in its largest foreign deployment since 1945.
Iraq owes Japan $4.1bn, but this rises to $7.75bn with late penalty fees.
"Japan would be prepared to eliminate the vast majority of its Iraqi debt if other Paris Club creditors are prepared to do so," a statement by the Foreign Ministry said after the meeting between the two men.
Most of the debt results from hospitals and power stations built by Japanese firms in the 1970s and early 1980s.
The government later took on the debts incurred by private companies.
Japan's pacifist constitution, adopted after World War II, forbids the country from using force to settle disputes.
A special law allowing the deployment of troops was passed by Japan's parliament in July, but only under the condition that the troops be sent to a place away from combat.
The deaths of Japanese diplomats in Iraq intensified debate
The first detachment of air force personnel have already gone to Kuwait and Qatar to prepare for the arrival of a larger unit in January.
Most of the troops will be based in south-eastern Iraq, where they will help restore water services, offer medical aid and rebuild schools.
Mr Koizumi has said Japan has a responsibility to help restore stability to Iraq.
"We cannot be absorbed in ourselves. We must lend our strength for the reconstruction and peace of other countries."
However, recent opinion polls have suggested that up to two-thirds of the Japanese public are opposed to sending military personnel to Iraq.