Volkswagen is to buy a 20% stake in Suzuki Motor for 222.5 billion yen (£1.5bn).
Suzuki will invest up to half of that amount received from Volkswagen into shares in the German carmaker.
In a joint statement the two companies said that they had "reached a common understanding to establish a close long-term strategic partnership".
The driver for the deal for VW was, analysts said, its desire to exploit Suzuki's expertise in making small, fuel efficient cars.
The deal is expected to be completed in early 2010.
"Two of the world's leading carmakers are joining forces and preparing to meet the growing challenges that lie ahead," said VW chief executive Martin Winterkorn.
"Together we can maximise our opportunities for growth."