China's Auto Industry Faces Period of Adjustment

Jan 17, 2005 Ι Industry In-Focus Ι Auto Parts and Accessories Ι By Philip, CENS
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After growing at a hectic pace in recent years, China's auto industry slowed down significantly in 2004 as a result of the government's macroeconomic adjustments and the reluctance of consumers to buy cars in anticipation of further price cuts. Despite the slowdown, industry insiders still maintain a rosy long-term view of the Chinese auto market.

Total auto sales in China in 2004 are estimated at 5 million units, up 15% over the year before, including 2.4 million sedans. Most observers would consider this a robust rate of growth—except in comparison with 2003, when sales soared by 35%.

The growth trend began to turn downward in May following announcement of the macroeconomic adjustment policy which, among other things, put a damper on the auto loans which were a major force behind the growth of auto sales in recent years. Outstanding auto loans stood at 180 billion renminbi (US$21.76 billion at US$1:RMB8.27) at the end of 2004—and a full 100 billion RMB of that debt was bad.

Quota restrictions on auto imports are expected to be removed this year, thanks to the end of China's five-year grace period following its accession to WTO membership. Under the country's WTO commitments, the tariff on cars will drop to 30% this year, representing a decline of 7.6 percentage points for autos over 3,000 c.c. in engine displacement and a drop of 4.2 points for cars under 3.000 c.c. The tariff is scheduled to fall farther, to 25%, by July 2006.

Insiders note that each cut of one percentage point in the tariff translates to a reduction of 0.3% to 0.5% in the price of imported cars. Lower prices for imports are likely to force local carmakers to reduce their prices accordingly in order to remain competitive. In fact, overcapacity has already forced the carmakers to slash their prices, which have dropped 25% over the past three years and 10% in 2004 alone

A Necessary Adjustment

Industry watchers believe that China's auto industry is entering a period of adjustment, and that its heyday of fast growth and high profits are gone. Thanks to rapidly rising incomes, especially in the coastal provinces, the country's auto market has been expanding at an annual clip of around 30% in the past several years, boosting sales from 1.8 million vehicles in 1999 to 5 million units last year. As a result, China has surpassed Germany to become the world's third-largest auto market, after the United States and Japan.

Government protection has enabled Chinese automakers to price their products unnaturally high, and to make high profits. General Motors, for example, earned a profit of US$400 million on sales of 400,000 vehicles in China last year; in North America, GM had to sell 5.6 million vehicles to make double that amount.

The class of nouveau riches created by China's rapid economic development has built up a substantial market for imported luxury cars. BMW, for instance, sold 18,000 vehicles (half of them priced at more than a million RMB) there last year, making China its seventh-largest export market.

Domestic and foreign manufacturers have rushed in to take advantage of the burgeoning Chinese market. The three leading domestic manufacturers—First Automotive Works, Shanghai Automotive Industry Corp., and Dongfeng Motor Co.—chalked up total sales of 1.2 million vehicles, including 700,000 sedans, in the first half of 2004. This was 45% of all vehicles and 60% of all sedans sold in China during that period, leaving relatively meager pickings for the 130 other local automakers. Most of the world's major auto manufacturers are there, generally in joint ventures with local partners.

Industry watchers predict that China's auto market will expand at a relatively moderate 15% this year, and that growing competition will force suppliers to cut prices further—perhaps by 10% annually for several years—and accept a continuous shrinkage of profits. This situation will likely bring on a major shakeout in the industry.

Nevertheless, industry observers remain optimistic. Auto ownership in China today is only eight autos per 1,000 population, compared with 970 in the U.S. and 600 in Western Europe. As incomes rise and auto prices fall, there is tremendous potential for the expansion of auto sales in China. Insiders believe that auto sales there will top 10 million in 2010, boosting China past Japan to become the world's second-largest auto market.

Foreign Investment

Major international automakers are investing in China to take advantage of the huge market potential there. One is GM, which plans to pour US$3 billion into a venture with Shanghai Automotive to double the output of autos to 1.3 million vehicles annually by 2007. DaimlerChrysler, in cooperation with Beijing Automotive Industry, will invest 1 billion euros in the production of top-of-the-line Mercedes-Benz models. Ford has decided to invest US$1 billion to expand its annual capacity in China to 500,000 vehicles annually within the next few years, and to set up a world-class R&D center there. Volkswagen, which earns one-third of its profits in China, plans to invest US$6 billion there over the next few years.

Some Chinese automakers have started to expand their sales overseas. Exports of autos from China soared 84% in the first five months of 2004, to 27,900 vehicles. The Chery Automobile Co., for example, has targeted exports of 250,000 sedans to the U.S. by 2007, with help from an American auto distributor. To help meet that goal, the company is undertaking a major capacity expansion. Chery chalked up total sales of 90,000 vehicles in 2004.

The manufacture of auto parts is another promising business in China, with the involvement of foreign companies bringing a striking improvement in quality in recent years. The country currently has about 40,000 parts makers, 1,000 of which are joint ventures with foreign companies. This foreign involvement has been a major force in the booming expansion of the China's auto-parts exports in recent years.

Exports of auto parts from China rose 32% in 2003, to US$3.2 billion, and soared another 70% in the first three quarters of 2004, to US$3.96 billion. The country's auto-parts exports consist mainly of tires, gauges, electronic devices, shock absorbers, universal joints, and rims. The top export markets are the U.S., Europe, and Asia. A representative case is that of the Wanxiang Group, which chalked up exports worth US$400 million to the U.S. in 2004, accounting for around a sixth of its total sales that year.

Industry watchers feel that the next five years will be a critical period for the development of the Chinese auto industry. They believe that it will experience a major consolidation, with only those manufacturers that are able to upgrade production efficiency and technology surviving. For this transition to go smoothly, the government will have to give up its intervention and wean the industry from its protection, so that the market function can operate property. If this happens, a stronger auto industry will emerge in China and boost its position in the global market.
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