Fiat has signed a memorandum of understanding (MoU) with the Serbian government to establish a joint venture with Zastava.

Fiat and Serbia would establish a joint company, 70% owned by Fiat, to invest EUR700m in the production of two new models at the Zastava plant, reported Reuters.

Serbia's economy minister, Mladjan Dinkic, told reporters that Fiat plans to start production of a small car by the end of 2009, and add a second medium-sized model by the end of 2010. He signed the MoU along with Fiat vice president Alfredo Altavilla.

According to dpa, the joint venture hopes to produce around 200,000 cars a year.

Fiat has supplied vehicle technology to Zastava under licence in the past - going back as far as the 1950s in fact.

Volkswagen was also in the running to become a partner for Zastava, which was seen as opportunity to set up a low-cost car brand along the lines of Renault's Dacia. China's FAW was also reportedly in the bidding.

Having suffered heavy bombing during the war in 1999, Zastava plants resumed vehicle manufacturing and this year are expecting to build around 18,000 cars. A range of cars are in production including the Zastava 10, which is based on the second generation Fiat Punto. In July 2007, Zastava signed a deal with Opel to build the old T3000 Astra Classic II under licence. The contract allows for 30,000 Astras to be assembled between 2008 and 2012.

See also: EMERGING MARKETS ANALYSIS: Decision time as Zastava bids to become another Dacia