Anywhere there’s a gold rush, competitors have to worry about getting caught on the bust-end of a boom-bust cycle. With the growth of China’s car market projected to roll all the way to about 20m units annually, automakers hoping to cash in on booming sales have to wonder whether their investments in Chinese capacity will actually be used efficiently. And, as the European market is learning, government consumer incentives can also inflate projections, only to create a collapse in demand after they are phased out. These factors have combined to create a bit of a panic about the possibility of a Chinese-market oversupply, as financial analysts start reigning in automakers’ rampant Sino-optimism.
The background for fears of a Chinese oversupply can be found in the huge capacity expansions planned by some of the auto industry’s biggest global players. China’s heavyweight, Volkswagen, is planning on spending nearly $6b expanding its Chinese capacity by 2012. Nissan is expanding capacity by 70 percent, and Toyota and Hyundai are building new plants as well, while domestic competitors continue to ride growing sales to further expansion as well. After all, Chinese sales grew over 45 percent last year, and are projected to grow another 20 percent this year. Why wouldn’t more factories be a good idea?
The answer to that lies in the Chinese government’s tax credits for vehicle purchases. BusinessWeek reports that China had cut tax rates on cars with engines of less than 1.6 liters displacement to five percent last year. But with sales booming, China has already raised that rate to 7.5 percent in December, and will likely raise it back to its previous ten percent level by the end of this year. And though an increase of 2.5 percent doesn’t seem like much, consider that this incentive targets the lowest end of the market, where much of China’s auto sales volume growth is expected. And where incentives make the most impact.
But with car sales in the rest of the world still suffering from an economic crisis hangover, executives aren’t anxious to contemplate the possiblity of a Chinese oversupply. Honda CEO Takonobu Ito opines:
China’s motorization is reaching the masses. Even after the tax break ends, demand shouldn’t drop very much.
GM’s Kevin Wale agrees, saying:
Every time the government changes their policy, it will have some impact, but the underlying demand is increasing at a very fast rate.
Even BMW’s Norbert Reithofer is joining the chorus, saying:
We will expand very dynamically in China even if the government takes that action
Get the picture? Meanwhile, the other side of the story comes from financial analysts like IHS Global Insight’s Paul Newton, who warns that even if the government doesn’t raise tax rates,
there is a fear that amid all of this investment and stellar growth, the vehicle market could start to overheat. The carmakers vying for market share in China may not want to admit it, but this risk is becoming a very real concern.
And Newton’s not the only one playing Cassandra in the face of strong growth in Chinese sales. MarketWatch reports that JP Morgan has downgraded several of China’s domestic automakers, including Dongfeng, Brilliance and Great Wall, on fears that the Chinese market:
can suffer from oversupply risks once the demand for small cars starts to soften as the stimulus policy’s effect starts to taper off
And UOB Kay Hian analysts raise another potential problem that will ring very familiar to students of China’s economic expansion: raw material supply issues. MarketWatch reports:
[Chinese] car makers may be particularly hard hit by those price cuts because of higher production costs, with steel prices in China expected to “surge in tandem with imported iron-ore prices,” the UOB Kay Hian analysts said. They warned that Chinese autos have an “unfavorable risk-reward balance,” and said they believe auto stocks are “unlikely to outperform the market in the next 12 months.”
But don’t worry too much… Americans are experts at beating demand out of even the most challenged markets, and they’re here to help. Sort of. According to Automotive News [sub], GM and Ford see only one major problem with the Chinese market: they pay cash. With 90 percent of Chinese-market sales taking place without financing (thanks to China’s impressive savings rates), Detroit’s finance boys see opportunities to not only unlock demand amongst poor, rural Chinese consumers, but also to get cash buyers to upgrade to a more expensive vehicle (making tax credits on entry-level vehicles less relevant). And it’s not just Ford and GM that are counting the interest dollars to be made on auto finance: Geely, Guangzhou, Beijing and other domestics are opening finance units as well.
If these firms can overcome China’s savings-oriented, pay-cash consumer culture by making auto loans more accepted and accessible, analyst fears of an oversupply could well be a false alarm. If the history of America’s auto industry (especially the part between the Model T and the rise of GM) teaches us anything, it’s that the cash-only, basic-transport market eventually gives way to a credit-driven, social-status market. There’s no reason to believe the same won’t be the case in China.