When Fiat SpA launches a new version of its popular Panda city car Wednesday, the Italian auto maker is likely to trumpet it as the first victory in a €20 billion ($26 billion) campaign to revive its manufacturing in its home country.

But, faced with a slowing economy in Europe next year, the car maker risks having to curtail the plan that would more than double production capacity by 2014, according to The Wall Street Journal.

"We need to be cautious," Fiat Chief Executive Sergio Marchionne said in an interview Tuesday. "We know and have been very clear on what we are doing with the Mirafiori plant [in Turin]. With the other two plants [Cassino, in Italy's Lazio region, and Melfi, in the country's south] we will have to watch what happens in the next five to six months before we make full commitments there."

Thanks to the sovereign-debt crisis and a tempestuous relationship with labor unions, Fiat has already taken its time retooling its Italian factories. Market observers say any further delay could compromise its already-weak position against Volkswagen AG and other rivals in Europe where it has yet to fully renew its aging product offering.

Although its U.S. partner Chrysler Group LLC has enjoyed a strong recovery in sales in the U.S., Fiat has had no such luck in Western Europe, its traditional market. In the first 10 months of 2011, Fiat as a group suffered an 11 percent drop in unit sales, the largest decline among the region's big auto makers, according to industry figures. Its market share fell nearly a percentage point to 7.3 percent. In the third quarter, Chrysler was responsible for two-thirds of the group's profit. In Europe, Fiat is unprofitable and is trying to break even by 2014.

And next year doesn't look promising. At a news conference earlier this month, Mr. Marchionne forecast a flat European car market—at best. "If you were to have a structural failure on the financial market or the euro, then all bets are off," he said at the time.

Although Fiat has the money to survive 2012 and pay off any expiring debt, it could be forced to slash spending on its plan by more than €5 billion, said Morgan Stanley analyst Stuart Pearson. "It could compromise its investment in product," Mr. Pearson said.

Under the plant-refurbishment plan, initially dubbed Fabbrica Italia, Fiat aims to boost capacity at the company's five Italian factories to 1.4 million cars and vans by 2014—part of Mr. Marchionne's wider strategy of gaining scale through Fiat's merger with Chrysler, of which it owns 53.5 percent.

Nearly two years after the plan was unveiled, Fiat will show off the new Panda model, made at the Giambattista Vico plant in Pomigliano d'Arco, on Wednesday. "It sets a new bar because this is the most industrially advanced plant that Fiat or Chrysler has," Mr. Marchionne said. "This is a huge step forward."

But the second model from the program won't come out for another year. And this means Fiat will depend on factories elsewhere in Europe—Serbia, for example—to refresh its lineup.

Part of the delay stems from Mr. Marchionne's insistence on implementing new working conditions governing everything from coffee breaks to overtime before spending a single euro. He even threatened to move production outside Italy if he didn't get what he wanted, saying that Fiat's factories in the country had to become more efficient.

In the end, Mr. Marchionne succeeded in persuading workers to vote in favor of the changes at three factories, but this took the better part of a year. And on Tuesday, Fiat said it had reached an agreement with metalworkers unions to extend the new labor contract to all the remaining employees in its home country. The agreement, Mr. Marchionne said, will "allow us to move on and manage Fiat. We have been in gridlock forever."

Fiat also briefly halted an investment of more than €1 billion at its Mirafiori factory after changing plans for a new model to be made there. The investment in the plant was further held up by a legal challenge from the Fiom-CGIL, the only union to hold out against the new working conditions.

Fiat's predicament is in part the legacy of decisions made at the start of the financial crisis, observers say. When the crisis first struck in late 2008, the company cut spending and slowed the pace of product development, arguing that it was pointless to bring out new models when the market was in the doldrums. The result, however, is that Fiat has been slowly overtaken by its rivals, which kept rolling out new models.

Mr. Marchionne has acknowledged the danger of delaying new products for too long. "You're going to tire yourself out of a market if you don't keep the portfolio alive," he said during a recent conference call. "The continuous introduction of products…is going to help, certainly in terms of maintaining [market] share," he said.

And, he added, when it comes to keeping costs down, Fiat has the option it has repeatedly used in Italy of getting workers to stay home on reduced pay for months at a time.

But the bulk of Fiat's efforts to catch up with rivals will only come to fruition in 2013 when a major overhaul of its product offering for Europe will see it roll out 11 new and updated models. Its refitted factories in Italy will contribute.

For UBS analyst Philippe Houchois, the fact that Fiat has decided to invest in Italy is more important than how much it invests.

He said it is a mistake to focus on the €20 billion figure. "When they announce these grand plans, car makers always highball the numbers," he said.

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