Auto Industry, Talking Point

Into the slow lane?

A drop in sales leads to questions about China’s car market

New cars are seen at a parking lot of Shanghai Volkswagen's car park in Shanghai

A lot in the lot: Volkswagen is one of the carmakers finding it tougher in the Chinese market

The four volumes of Zhu Rongji on the Record offer a compilation of the speeches and memos from China’s vice premier and premier between 1991 and 2003.

Zhu originally planned to end the series with his farewell address to the State Council in which he recounted his five-year premiership.

But before the final draft went to print in 2011, he changed his mind on the concluding chapter.

Instead he picked a talk to public transport workers from 2003, in which he had warned against state subsidies for car ownership.

“Honestly I don’t agree everyone should own a car. This isn’t suitable for China. We simply have too many people… Where would the fuel come from? The majority of our oil comes from imports. And let’s not forget the vehicle emissions. Pollution will become an even more worrying issue,” Zhu predicted.

According to Phoenix TV, the last-minute inclusion of these remarks indicated Zhu’s disapproval of some of the policies of his successors, especially those state subsidies offered to car buyers and automakers which helped China overtake the United States as the world’s largest car market in 2009.

Car purchases have continued to grow since then, although at a slower pace for much of the last year. But in June sales saw a rare decline. Auto industry executives are pondering if the stall is just a hiccup, or more structural in nature. With signs of car fatigue from city dwellers – thanks to traffic jams and vehicle pollution – Zhu’s forecast is regaining attention.

Time to apply the brakes?

According to the China Association of Automobile Manufacturers (CAAM), sales dropped 2.3% (year-on-year) in June to just over 1.8 million vehicles.

Even more notable was that the biggest component of vehicle sales – those for passenger cars – dropped a larger 3.4% to 1.5 million units in June.

This level of monthly decline has happened only twice before: two years ago when a week-long holiday disrupted buying patterns and in 2012 when sales were hit by customer boycotts of Japanese cars.

The latest skid coincides with the economy growing at its slowest pace in decades, hampering demand among prospective purchasers. “Most auto executives had been forecasting 2015 sales in China to slow to a high, single-digit percentage gain over 2014, but that now looks optimistic,” the Wall Street Journal reckons.

For the first six months of the year, car sales managed to climb 4.8% over the same period in 2014. Again, that was the CAAM survey’s weakest reading in six years. It had previously predicted that overall sales (including commercial vehicles) would grow 7% this year. But it has now cut its forecast to 3%, indicating a further slowdown in the second half.

Who is hardest hit?

The slowdown is hurting foreign and local carmakers alike.

Brilliance China, the joint venture partner of BMW, said last week its net profit for the first half of this year dropped 40% from 2014. The profit warning came despite the Rmb5.1 billion ($820 million) in subsidies that BMW gave Chinese dealers in January (a none-too-happy bunch who had complained about unrealistic sales targets and excess inventory – see WiC287).

Great Wall Auto, one of the few local manufacturers that doesn’t rely on foreign partners, sold almost 20% more cars in the first six months of 2015, fuelled by strong sales of locally-made SUVs (sports utility vehicles being one of the sweeter spots in the market this year). But year-on-year growth collapsed to 4.7% in June (compared with 26% in May) because of the introduction of a number of new SUV models by rivals. Great Wall’s share price has slumped more than 50% in the past two months, wiping out $15 billion of market value.

As a whole Chinese carmakers have started to win back some of the market share lost to brands made by foreign rivals, in part because of stronger sales performance for cheaper, homegrown SUVs. By the end of June, domestic brands commanded 41.4% of the market, up from 37.8% a year earlier. German brands showed a small drop to 19.7%, as did American brands to 12.1%, according to the CAAM survey.

CAAM’s latest findings have sent shockwaves as far afield as Wolfsburg and Detroit, Reuters notes, with Volkswagen and GM also “feeling the effects of a slowdown in a market that has been their big profit engine”.

Reuters estimates that Volkswagen depends on China for more than half of its net profit and 71% of its free cashflow, including income from royalties.

GM, meanwhile, makes 40% of its net income from China.

As recently as March Volkswagen posted record operating profits of $19 billion for 2014, with China being the major contributor. But earlier this month it announced a 3.9% decline in first-half deliveries in China to 1.74 million vehicles – the first such retreat since 2005. Last week there was more bad news: Volkswagen’s Chinese revenues were down 6.7% for the same period.

Slower sales the only worry?

Volkswagen has 18 plants in China, and the German firm said last year it will invest more than $25 billion alongside its local partners by 2019. GM’s joint venture with Shanghai Auto pledged in April to spend $16 billion by 2020 in order to keep up with Volkswagen.

Other automakers have been adding capacity too. Hyundai Motor is building two more plants, while Renault has a new plant about to commence operations.

“For years, auto executives visiting China would cite the country’s large population, low ownership rates and rising incomes in justifying the billions of dollars spent to build factories,” Bloomberg comments. “These days, they are asked about price wars, struggling dealers and falling sales, underlining the rising concerns over China as the engine for global growth.”

Jaguar Land Rover is another of the foreign carmakers which might be ruing its overexpansion. The luxury car unit of Tata Motors said last week it will cut sales targets in China, without giving further details. The starting price of JRL’s China-produced Evoque SUV was reduced immediately by Rmb50,000 to Rmb398,000 from July 1, Bloomberg reported. But according to CBN, some dealers have cut the sale price for imported JLR models by as much as Rmb100,000.

The more difficult conditions coincide with the first locally-produced Land Rovers emerging from the company’s new production plant in Jiangsu, a joint venture established in 2012 with Chery Automobile (see WiC271). That isn’t JLR’s only problem, say local media.

“For JLR the most difficult issue isn’t about stuttering demand in the short run, but indeed how it could better manage the transition from selling imported cars to locally-built models. This is also about how it could better manage its relations with its joint venture partner while maximising its long-term interest in China,” 21CN Business Herald has suggested.

Is the slowdown structural?

The steep correction in the Chinese stocks is being blamed for dampening demand for new cars. Growing numbers of buyers have cancelled their orders since the equity market rout started to shake consumer confidence in June – often forfeiting their downpayments .

“The plunging stock market is essentially a meat grinder, shredding money meant for buying cars,” Cui Cui Dongshu, secretary-general of China’s Passenger Car Association, told Bloomberg.

The dealerships agree. “When people are making money in the stock market the car buyers pay in cash and offer each of us a big lai see [a red envelope containing a monetary gift]. Now we go three or four days without a deal,” a Porsche salesman complained to the Beijing News.

With most of the major carmakers raising their production capacity, concerns have been growing about a supply glut (see WiC270).

The leading automakers counter that the downturn is temporary, shaped by the stockmarket slowdown, and that their long term confidence in the market is unshaken. It’s also true that car ownership levels in China continue to trail those in developed markets by some distance. But Beijing News wonders whether Chinese President Xi Jinping’s corruption crackdown and austerity drive is contributing to a “new normal” for the industry, with weaker demand for luxury vehicles and fewer orders from the public sector likely to be a more permanent state of affairs. Stronger growth in the second-hand car market is also posing competition for new vehicle sales for the first time. In the US the ratio of used-car to new-car sales stands at 3 to 1. In China it is only 1 to 4, and China Auto Post points out that secondary sales grew 8.7% last year, outpacing new cars sales growth for the first time.

Policy changes also a factor?

If some of the reports from the official media and the state think tanks are indicative, supporters of public transport seem to be gaining ground on proponents of private car ownership.

Perhaps Zhu Rongji’s predictions about the potential hazards of widespread car ownership are becoming more widely accepted. The Economic Information Daily notes that only about 10 million cars were privately owned in 2003 – the year that Zhu Rongji retired as premier. As of last year that had rocketed to more than 154 million. “This breakneck growth rate cannot go on forever,” the newspaper warns.

The Development Research Centre of the State Council shares some of these concerns, and suggested recently that state subsidies should only be offered to encourage ownership of more environmentally friendly cars.

The backlash against the car-owning culture is growing in cities too, especially those most afflicted by congestion and unhealthy vehicle emissions in residential areas.

The result: almost every major Chinese city has introduced some form of control over new vehicle purchases by capping the number of new licence plates issued or only awarding them by lottery.

(For prospective buyers another advantage of a second-hand car purchase is that the vehicle comes with pre-existing licence plates.)

Other measures seem set to reduce some of the enthusiasm for car ownership too. In Shanghai, for instance, it takes at least three months and costs around Rmb10,000 to get a driving licence (and more if the driver fails the written exam and the practical test). As a result applicants have been travelling to South Korea where the test is said to be easier and cheaper. Then they convert their Korean licence to a Chinese one when they return home.

The number of Chinese tourists going to Korea to do this rose from 7,000 in 2010 to around 25,000 in 2013.

But even this loophole has now been blocked by the Shanghai authorities, with the China Daily reporting this week that city police are dismissing applications to exchange South Korean driving licences for local ones.

Where Shanghai leads, other cities often follow – so perhaps we can add driving schools in Seoul to the list of businesses now worried by China’s auto slowdown…

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