Sanyo, which has the biggest global market share of lithium-ion batteries used in personal computers and mobile phones, said it would spend $790 million over the next seven years for the project, which aims to begin mass production in 2009.
All the world's leading carmakers are working on developing vehicle-use lithium-ion batteries to replace nickel-hydride ones currently used in petrol-electric hybrid cars, since they can store more energy in lighter, smaller packs.
Volkswagen showed a Golf diesel-hybrid powered concept at last year's Frankfurt motor show and has indicated it is considering forms of electric power for future small cars that it is considering.
Japan's Toyota, Nissan and Mitsubishi have separate joint ventures with Matsushita Electric Industrial, the NEC group and GS Yuasa, respectively, to mass-produce lithium-ion batteries.
"Our focus in future will be directed more strongly at making electrically powered automobiles alongside ones driven by more efficient combustion engines," Volkswagen Group CEO Martin Winterkorn said in a statement.
"This cooperation is an important step for us."
Sanyo and Volkswagen are currently collaborating on the next generation of nickel-metal hydride systems. Sanyo has separately supplied batteries for hybrid vehicles made by Ford Motor and Honda.
Production of the lithium-ion batteries will initially begin on a new manufacturing line to be set up at Sanyo's Tokushima factory in western Japan, it said in a statement.
It will look for a new location for further production from early 2010, to meet future demand of about 15,000 to 20,000 units a year, it said.
Sanyo also aims to develop and supply lithium-ion batteries for use in rechargeable plug-in hybrid vehicles starting in 2011.