Production will commence within 18 months after Toyota committed to building 10,000 petrol-electric Camry models each year from 2010.
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The decision is tipped to lead to a local explosion in green car technology and boost the Victorian economy by $150 million annually.
Prime Minister Kevin Rudd, who was present at Toyota's Japanese headquarters in Nagoya for the today's announcement, says the car giant will receive a $35 million subsidy from the government's Green Car Fund.
“We are delighted Toyota has decided to invest in the Australian car industry and build the hybrid Camry at Altona,” Mr Rudd said.
The hybrid car will use one-third less petrol than a conventional model and save the average motorist $1,000 a year in fuel costs, it is predicted.
Toyota president Katsuaki Watanabe says Australia had joined Japan and the United States as part of Toyota's hybrid family.
Mr Watanabe conceded the hybrid Camry would be more expensive than the regular model but suggested the $35 million subsidy might be used to keep the retail price down.
Victorian Premier John Brumby says the decision will secure jobs for the state's car workers.
“With car manufacturers moving on a global scale to produce green, fuel-efficient cars, it is crucial that the Victorian auto industry secures a slice of this investment, which will add $150 million annually to our economy,” Mr Brumby said.
The Australian Manufacturing Workers' Union (AMWU) says the deal is good news for Australia's export future.
“We've been saying for some time we need a plan for this industry as we start to consider the type of vehicles people will be driving in the next 10 to 20 years,” AMWU national secretary Dave Oliver told ABC Radio. “Not only for the domestic market but to position itself for export strategies.”
Car industry experts say today's announcement will lead to an explosion of green car technology locally.
“The kind of response it's going to trigger from other manufacturers is to look at their own products and how they can be made more environmentally friendly,” Monash University manufacturing specialist Richard Cooney told ABC Radio.
But the announcement didn't receive universal praise.
Opposition climate change spokesman Greg Hunt said it was “hypocritical” for Mr Rudd to talk up his green credentials and offer a subsidy after deciding to means test the solar panel rebate.
The Tourism and Transport Forum says hybrid cars are a bridging technology between gas guzzlers and the next generation of zero-emission cars.
“Models such as the hybrid Camry will undoubtedly play a useful role in the transition from the old technology to the new,” forum manager Stewart Prins said.
“But they are not the long-term answer to the twin challenges of soaring petrol prices and greenhouse gas emissions.”
Australian Democrats leader Lyn Allison said a smaller model should have been chosen, as the Camry weighs an inefficient 1,450kg.
“We are still addicted to heavy cars,” the Victorian senator said in a statement.
“Lower vehicle mass is essential for maximum efficiency.”