The pair are joining forces with playwright David Greig to create a production which will premiere at the Royal Lyceum Theatre in Edinburgh next year.
Glasgow-born Knopfler, former guitarist and song-writer with the rock band Dire Straits, has written a wealth of new music and songs for the stage show, which will also feature favourites from the original soundtrack.
The Lyceum is joining forces with the Old Vic in London, where Local Hero will transfer after an extended run in Edinburgh in the spring of 2019, to create what is billed as a “re-envisioning” of the 1983 film. It is hoped the musical, which is set to cast a new light between Scotland and America, is will also be staged in the US.
In Forsyth’s original film, Burt Lancaster played the American oil tycoon who sent one of his executives to a remote corner of Scotland to seal a deal to buy an entire village and its beach for a new refinery - with unintended consequences for the company. Peter Capaldi appeared in his first screen role, alongside Fulton Mackay, Denis Lawson, Jenny Seagrove, Peter Riegert and Alex Norton.
The production, which is described by Greig as “a dream come true,” is the result of several years of discussion between the key players.
Forsyth, director of That Sinking Feeling, Gregory’s Girl and Comfort and Joy, insisted he would only participate if Knopfler was also involved.
Speaking exclusively to The Scotsman, Greig said: “Local Hero is going to be a brand new home-grown production of Bill Forsyth’s story, with new songs and a new score by Mark Knopfler.
“Some of the classic instrumental themes will be there - it would be insane not to include them - but he has written a whole bunch of new material, which is absolutely fantastic.
“Bill and I are working on the script for about a year, trying to get it into shape, find out what it is as a stage thing and working with Mark to create something that is complete and organic.
“I really want everybody who loves the film to come to it, and recognise what they love about the film in it. But a lot of people won’t have seen it. I want them to come and find this new story and immediately connect to it. It needs to work on its own terms. We all want to create something new that belongs on the stage.
“The story will essentially be the same. Local Hero is a very simple tale. It’s almost a fairytale, about an oil baron who wants to buy a beach and all the outcomes of that.
“What’s so fantastic about it is all the little detail of the interaction and the human yearnings and longings in it.
“What’s been really exciting is to take Local Hero’s character and emotional study into a musical format and also to really think about what a Scottish musical might be like.”
“For me, it been about going back to get the best of what the film is and that means the best of what Bill Forsyth is. He is one of our greatest artists and a real shaper of Scottish culture. His tone is so unique.” Matthew Warchus, artistic director at the Old Vic, said: “Bill Forsyth’s Local Hero is high on my list of all-time favourite films.
“I have watched and re-watched it many, many times and never tire of its perfect mixture of situation comedy and romance, combined with a strong and important message.”