By on April 28, 2010

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.

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18 Comments on “Is China Headed For Oversupply? Not If The Credit Boys Can Help It...”


  • avatar
    educatordan

    We’ll see how fast and if tastes change in that respect in China. BS keeps telling us that it is an ingrained part of their culture he doesn’t see shifting an time soon. Actually the way he talks I’d be shocked to see the Chinese taking on auto loans during this decade.

    I know why the Detroit boys want finance to happen, they make more money on that than just about anything else. Ford Credit has been Ford’s best operation from a financial standpoint for more than a decade.

  • avatar
    undrgnd40

    look how well a credit heavy, social status driven market has worked out for the USA. who will buy all our debt when china becomes just like us?

  • avatar
    tparkit

    The intermediate-term problem for China’s auto market isn’t the price of raw materials, or the availibility/lack of credit.

    The problem is that China’s economy is a house of cards. Start here:

    http://globaleconomicanalysis.blogspot.com/2010/02/goldman-says-something-brewing-in-china.html

    http://globaleconomicanalysis.blogspot.com/2010/04/chinas-nonexistent-rebalancing-act.html

    China’s latent demand for cars is huge, but – as Japan is proving – an economic collapse after a government-driven boom/bust can last for decades.

    • 0 avatar

      The author of that blog reads too much Gordon Chang (yes, that one, who predicted China would collapse 5 years ago and is constantly pushing the doomsday deadline)

      And China is not Japan.

  • avatar
    Dimwit

    As everyone keeps reiterating, Japan and the US are mature markets. Nothing that happenss in them currently has any bearing on what China’s doing.

    That segment of the market is in a hypergrowth stage because *nothing* is a replacement. All the small, cheap cars are My First Car and it’ll be decades before there will be any change to that. Even at their growth rate China is that far behind.

  • avatar
    ronin

    China’s car market will collapse. It’s propped up now by incentives, but the credit backlash is waiting in the wings, as China is already seeing it balance of trade turning upside down, as its exports diminish and its imports grow. Credit is a mean motor scooter as the rest of the world has learned, and there are only so many $1500/year Chinese consumers, and lots of empty stores, office space, cities… China is an overheated bubble waiting for a pin. But then, so is Europe, North America, Eurasia…

  • avatar

    From NYC (phew…)

    1.) The incentives were overrated. Take at $4000 QQ. 10% tax is $400, 5$ tax is $200, 7.5% tax is $300. Big deal. The Chinese just shrugged their shoulders at the tax rise. Note that the the 7.5% came in at the beginning of the year and look at first quarter 2010 sales. To the moon.

    2.) Congratulations on trying to sell on credit. The USA will legalize prostitution and marijuana before there will be a wide-spread on-credit purchase of cars in China.

    3.) People don’t see the forest for the woods. There are 1.5b people in China. Maybe some 5% own a car. This market has a long ways to go. It won’t grow at 80% to 100% rates. But 15% to 20% a year is very much in the cards.

    Currently, both GM and VW, the big ones in China, are capacity constrained and lose market share because they can’t make them fast enough.

    Dimwit is no Dimwit. And distrust ANYTHING Global Insight says. They are consistently wrong.

  • avatar
    gimmeamanual

    The market will grow; slow or fast, it will continue grow, and importing cars in from under-utilized facilities in Europe/US/Japan is not an option.

  • avatar

    Sometimes in the future the saturation of the Chinese market will happen. It’s interesting to see how various manufacturers will react before that. In 2005-06 in US many in banking and real estate were convinced that the real estate market will grow at 8% for ever. We now know how long that “ever” lasted. The passing from cash to credit in China could be a buffer and also a signal before saturation.

    @ educatordan: That reminds me what people were saying in the 90s about GM being a financial institution which makes cars on the side.

    • 0 avatar

      Sure, sometime in the future any market will saturate. Europe is saturated. the U.S.A. is over-saturated. China? How many cars do we grant them a year? 20 million? Then it takes 35 years to saturate the market, no scrap assumed. Scary 50 million a year? Then it takes about 12 years, also no scrap assumed. With 1.5b people, the replacement market alone will keep several car companies nicely occupied.

      It is beyond me how anybody from the U.S.A. or Europe can look towards China or India and even consider “market saturation.”

  • avatar
    Dimwit

    FYI, China is not the US’s largest trading partner, Canada is. Their growth isn’t tied to the US as much as people would think. They can motor along quite nicely on internal growth.

    It’s all about the demo. The current upper echelon endured the long walk before settling into the executive suites. They hold the reins of the Command economy and are trying to steer the course. The next generation didn’t grow up with Bimmers but have them now and won’t give that up any time soon. When the current guys retire/die these guys will handle trade a lot differently.

    Behind them is the cell generation. THESE guys are computer/tech savvy, matured in this hyper growth era, will be comfortable with it and will generally have a family network available outside of China. Once these guys get the reins, look out! You ain’t seen nothing yet. Still that’s a conservative 25 years from now, barring any upsets from previous generations attempts on holding onto the power and outside stupidities influencing inside politics.

    The dragon has been released, but is just venturing outside the cage. Just watch.

  • avatar
    ronin

    The average engineer in China makes $5700 a year. Once he buys his house, how many $30,000 cars is he gonna buy? And how frequently? And how can he afford to buy even one car?

  • avatar
    Monty

    “The dragon has been released, but is just venturing outside the cage. Just watch.”

    +1 Dimwit

    The only niggling worry would be the fuel supply, but that will only speed the research and development of alternative fuels and drivetrains, and/or the search for more sources of oil.

    All one has to do is look at how quickly Japan industrialized into a consumer society after WWII; China’s population is ten times the size of Japan’s without the need to rebuild the country after a devastating war.

    Within my lifetime (and I have probably 25 to 35 more years on this planet) China will be the world’s most dominant economy, and will supercede the US as the currency standard. The torch will pass, and we can either bury our heads in the sand and let it pass us by, or we can hop on the train. The best education you could give your children now would be learning Mandarin and Cantonese.

  • avatar
    wsn

    BS fails to the the big picture. The Chinese state owned steel producers just failed at negotiating the price for raw iron ores from suppliers and have to pay 3x the price of a couple years ago.

    The Chinese RMB is seriously overvalued. Yes it’s undervalued for small toys exports, but it’s overvalued for big toys such as cars and raw materials. Producing more cars means importing more raw materials (steel, crude oil, etc.) and will in turn put more downward pressure on RMB. When RMB goes down, they won’t be able to buy the raw materials any more.

    Just look at the US. Look at how much was spend on the military, the aircraft carrier fleets. A major portion of that, was aimed at securing a stable and cheap raw material supply.

    China doesn’t have that. The only way out is to pay the US a protection fee for that in the form of debt purchase or something else.

  • avatar
    Dimwit

    I’m beating a dead thread here but I find China and its complexities fascinating. The fallacy here is that all roads must lead to the US. Do you honestly think that nobody on the planet will sell ore or other raw materials to the Chinese? Not likely. If you hadn’t noticed the largest steel companies are now Indian. Actually if you look around you’ll notice that almost all of the commodity processors are now located in either India or China. Getting the raw material in might take some effort but after that it’s a cakewalk. And Russia and Canada need to keep their balance of payments up as well. China is well poised going forward. Some of the western world economies should be so well off.


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