China overtook Japan as the biggest vehicle exporter last year, helped by its dominance in EVs.
Many foreign car firms are struggling in China, but Toyota -- the world's top-selling automaker -- said it wants to "match the unique needs of Chinese customers" with its new factory.
"We decided to establish a wholly owned company for the development and production of Lexus BEVs (battery electric vehicles) and batteries in Shanghai, China," it said.
Toyota aims to start production there after 2027, and said the new plant would create 1,000 new jobs with an annual output capacity of approximately 100,000 vehicles.
It will be China's second wholly foreign owned electric vehicle factory after Tesla's Shanghai plant. Other foreign companies making cars in the country run joint ventures with Chinese companies.
"Local Chinese members will take the lead in planning and developing BEVs" to suit local customers, Toyota said.
"Our goal is to become a company that is more loved and supported by the people of China."
- Forecasts up -
Toyota said Wednesday it expects to log a net profit this financial year of 4.52 trillion yen ($29.5 billion), up from its previous forecast of 3.57 trillion yen.
The "upward revision incorporates progress in strengthening earning power, backed by improvement efforts including product competitiveness", the company said.
Unit sales rose for hybrid electric vehicles between April and December, Toyota said.
But over the same period, in China, total vehicle sales dropped from 1.5 million to 1.4 million.
Lacklustre consumer spending and tough competition is making life hard for many automakers worldwide.
However, Toyota's strategy to offer a range of vehicles, including hybrids, has paid off in markets such as the United States.
Tatsuo Yoshida, senior auto analyst at Bloomberg Intelligence, told AFP that Toyota was once "extremely cautious about expanding its business in China due to concerns over risks such as technology leaks".
"However, the company has now shifted its approach to developing technologies and products tailored to the local market, ensuring acceptance by Chinese consumers," he said.
- 'Strategic move' -
China's government has supported the development and production of less polluting battery-powered vehicles, a field where Chinese manufacturers such as BYD are leading the way.
So Toyota's decision to build the Shanghai plant "is a logical strategic move", Yoshida said.
"Toyota's ability to make proactive investments in electrification (particularly BEVs) and its business in China, even when other auto companies hesitate, is a unique strength stemming from its abundant talent and financial resources."
Toyota also said on Wednesday that its new battery plant in the US state of North Carolina was ready to begin production.
The nearly $14-billion plant will start shipping batteries for North American electrified vehicles in April, the company said.
Honda and Nissan, Japan's number two and three automakers after Toyota, have also launched talks on a merger to help them strengthen their position on EVs and self-driving tech.
But Nissan shares plunged on Wednesday after the Nikkei business daily reported that the carmaker had decided to withdraw from merger talks, after Honda had proposed making Nissan its subsidiary.
nf-kaf-reb/mtp
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