The company said it planned to spend $20 million to start developing the assembly plant and ride-hailing service – part of a push into sub-Saharan Africa.
Thomas Schaefer, chief executive of Volkswagen Group South Africa, said they were trying to wean East African drivers off second-hand imports.
Volkswagen will produce three models; the Hatchback Polo, the Passat and possibly the Teramont, a large sports utility vehicle, it said in a statement.
The carmaker said it had registered a local company to run its ride-sharing service and signed up a local software firm to develop a smartphone application to hail rides.
Global ride-sharing companies such as Uber have not yet moved into Rwanda.
Volkswagen said 500-1,000 jobs would be created in the first phase of the investment, including the drivers of the first batch of cars for the ride-hailing service.
Schaefer said the service will feed demand for the assembly plant, since vehicles in the scheme will be driven all the time, forcing the need for constant replacement.
There were 300,000 cars in Rwanda last year, in a country of 12 million people, the CEO of the Rwanda Development Board, Clare Akamanzi, said as she welcomed the deal. Most of the cars on the roads are second-hand imports from countries such as Japan.