The company's current yoghurt manufacturing line has a capacity of six million cups a month which will be raised to 13.5 million with the new production line.
The three-year project will also expand Fonterra's daily milk requirement to 52,000 litres which would be supplied by 3,000 local dairy farmers.
"The project will include Fonterra establishing new raw milk collection centres throughout the country to assist in processing the required increase in volume," Reddy also said.
In the first year of the expansion project, Fonterra will focus on collection and processing of milk for yoghurt, while packing capacity will be enhanced during the second year, he said.
The company also plans to provide local dairy farmers with technical assistance on increasing production, pasture management and breeding as well as micro-finance schemes to expand their production capacity.
"Increasing our local milk supply allows Fonterra to have a buffer against the increasingly volatile international prices for milk powders and dairy products," said Reddy.
Apart from Anchor Newdale and Ratthi yoghurt brands, Fonterra markets flavoured milk and milk powder in Sri Lanka.
The company is co-operatively owned by more than 11,000 New Zealand dairy farmers with an annual turnover of 8.5 billion dollars.
Fonterra Brands Lanka is the company's largest consumer operation outside of Australia and New Zealand..