SHANGHAI (Reuters) - French car maker PSA Peugeot Citroen on Friday signed a deal to set up a 50-50 manufacturing venture with China Changan Automotive Group as it moves to ramp up capacity in the world's largest auto market.

The Peugeot-Changan tie-up on light commercial and passenger vehicles marks the latest foreign auto expansion in a market where General Motors, Volkswagen AG and others are competing for dominance.

The joint venture would have an initial investment of 8.4 billion yuan ($1.24 billion), PSA said in a statement.

The partners will focus initially on launching Citroen's DS line of premium small cars in China, as well as introducing a dedicated new brand for the venture, PSA said.

"The contract also allows for the joint venture to market, at a later date, further vehicles under the partners' other brands, Peugeot and Changan," it added.

PSA said the first vehicle was scheduled to be launched in the second half of 2012. The Shenzhen plant, in southern China, will have an initial production capacity of 200,000 vehicles and engines, with two production lines and an R&D centre.

A source close to the Chinese company had earlier told Reuters that under the agreement, PSA would team up with Harbin Hafei Automobile Industry Group, a subsidiary of Changan, to make light commercial vehicles and cars in south China.

"Changan and PSA will use Hafei's existing facilities in Shenzhen. PSA's DS series models are included in the portfolio," the source said before the announcement.

"It's a good move for PSA Peugeot as a new venture could expand its product line and hopefully help it win more market share here," said Zhang Xin, an analyst with Guotai Junan Securities.

A Peugeot tie is equally beneficial for Changan, the state parent of Chongqing Changan Automobile Co, which now operates a car venture with Ford Motor, other analysts said.

China, which eclipsed the US as the world's top auto market last year, has been a major bright spot amid a global industry downturn and a safe heaven for foreign auto giants.

PSA is already making Peugeot 408 and Citroen C5 sedans in partnership with Dongfeng Motor Group Co, but it lags most of its foreign rivals due in part to a limited portfolio.

The venture sold only 175,190 cars in the first half, equivalent to a third of Hyundai Motor and Kia Motors' combined tally and merely 15 percent of what GM sold in the country during the period.

The French automaker, however, has been actively seeking to expand its footprint in the country.

In November, as part of a plan to boost margins that relies heavily on emerging market growth, PSA unveiled a series of models designed to tap the booming Chinese market.

Sources told Reuters in May that PSA and Dongfeng, with a combined annual auto production capacity of 450,000 units, aim to build their third plant by the end of this year.

The greenfield facility, with annual capacity of between 150,000 and 200,000 units, is scheduled to be up and running by 2012.

Other foreign auto makers are also expanding.

GM, which already makes cars and light commercial vehicles with China's major auto groups SAIC Motor Corp and FAW Group, is selecting a site for a greenfield China plant, executives had said.

Volkswagen also pledged this year to add an additional 1.6 billion euros ($2.03 billion) to its previously announced 4.4 billion euro China investment scheme.

By 0857 GMT PSA shares were up 1.8 percent at 23.07 euros, outperforming the STOXX Europe 600 autos index, which was up 0.4 percent.