A downshift to less hectic growth in China may be both inevitable and healthier for the economy and the automotive industry, as well.

While fallout from the global recession still lingers in most countries, China is recovering well ahead of the pack. In the year’s first half, the economy grew 7.1%, as light-vehicle sales surged 27% to 6.8 million in response to Beijing’s vigorous pump priming.

The momentum carried into September, when sales of locally built vehicles soared 77.9% to 1.33 million, marking a 17.0% gain on August, as domestic deliveries exceeded 1 million units for the seventh straight month, the China Association of Automobile Manufacturers said. The result left China’s 9-month vehicle sales up 34.2% to 9.66 million, with passenger-car deliveries rising 41.9% to 7.24 million.

CAAM also reported new-vehicle production in October hit the 10 million-unit mark, making China the third country after the U.S. and Japan to build more than 10 million vehicles in a year. The group now is predicting full-year output of more than 12 million vehicles.

The rapid recovery is no accident. Credit controls put on Chinese banks in 2007 were removed, and the banks, urged to expand lending, did so with gusto. Some $1.1 trillion was passed out between January and June, a 200% surge from year-ago. This and a $586 billion government stimulus plan have succeeded almost too well.

“Surging investment, fueled by the most rapid bank lending in history, accounted for nearly 90% of China’s gross domestic product growth in the first half of the year, and that is worrisome,” Stephen S. Roach, an economist and chairman of Morgan Stanley Asia, says in a recent interview with the New York Times.

Analysts say external demand is not coming back any time soon, because the American consumer is dead in the water.

“Chinese growth this year was mainly boosted by government incentives because this was the only way to offset the rapid drop in exports, which have been declining every month year-on-year and were down over 22% in the first eight months,” says John Zeng, senior analyst with IHS Global Insight in Shanghai.

“Much of the focus was on the automotive industry, where results could be seen immediately.”

Signals are mixed now, raising serious doubts about whether the present pace can be, or should be, sustained. “The difficulties and challenges in the current economic development are still numerous,” China’s National Bureau of Statistics spokesman Li Xiaochao says.

China’s central bank warns much money may have been misspent on questionable government projects. Worries about fresh speculation in commodities, real estate and stocks triggered a sharp mid-August sell-off in Shanghai’s high-flying stock market.

The question on millions of minds today is what happens next. Although the stimulus plan still has more than a year to run, changes may be made, and experts anticipate a tightening up and dampening down of bank lending.

“There’s concern about overheating because the stimulants have been so stimulating,” says Tim Dunne, a senior analyst with J.D. Power & Associates. “The government wants to make sure to avoid creating an economic bubble.”

Another large surge in light-vehicle sales in 2010 would be difficult, Zeng says. “The base is quite high now. Government policy is not that clear. The incentives will be continued, but modified, and won’t involve such strong support for the auto industry.”

At a recent press conference, a senior Chinese official pointed out the government already has given away RMB12 billion ($1.7 billion) by cutting the purchase tax on vehicles with engines 1.6L or less from 10% to 5%.

Regardless, Zeng believes government allowances for people in rural areas will continue. The subsidies offer up to RMB5,000 ($735) per vehicle for those who purchase a new minibus or minitruck.

China’s Vehicle Sales Forecast
Year Passenger Light Commercial Total Growth
2009 7,202,000 3,829,000 11,031,000 +25.8%
2010 7,567,000 3,727,000 11,295,000 +2.4%
2011 8,309,000 3,743,000 12,052,000 +6.7%
2012 9,141,000 3,847,000 12,989,000 +7.8%
2013 9,947,000 3,985,000 13,933,000 +7.3%
2014 10,686,000 4,173,000 14,859,000 +6.6%
2015 11,400,000 4,413,000 15,814,000 +6.4%
2016 12,059,000 4,602,000 16,662,000 +5.4%
Source: J.D. Power Forecasting

Calculating simplistically that all of the 306,647 minitrucks and 1,078,015 minibuses sold in the first half qualified for the $735 subsidy, the government’s tab could be a hefty $1.01 billion.

J.D. Power reported in August “only the weakest companies (in China) are worried about meeting their full-year sales targets,” and with the auto industry continuing to bolster the economy, that prediction continues to play out.

“In the first half of the year, the biggest problems for OEMs and suppliers in China was a shortage of capacity,” Zeng says. “Now they are trying to hurry-back expansion. The big problem will be to create a balance between capacity, production and sales when government policy is uncertain.”

Says Dunne: “Auto makers in China follow the U.S. model and build their vehicles before they are sold. They want to avoid making the mistake recently made in the U.S. where too many vehicles were produced, overloading dealer lots and making it harder to find customers.

“It’s important to rationalize production, so the tail is not wagging the dog,” he adds. “They are not selling cars to keep their factories running, but running factories to sell cars.”

Ford Motor Co., for example, broke ground in September for a $490 million plant, it’s third in China. The auto maker’s sales in the first nine months reportedly reached 316,639, climbing 32% from year-ago, with September’s deliveries soaring nearly 80% thanks in large part to the Focus sedan, up 72%.

GM China Group is forecasting its sales this year likely will exceed 1.6 million units. The auto maker delivered 1.29 million in the first nine months, up 56% from like-2008. President and Managing Director Kevin Wale and other General Motors Co. executives have said China is a key part of GM’s future strategy.

Nevertheless, GM has reason for concern over whether the government will continue its industry subsidies, as 60% of sales in China this year came from its small-car Wuling Automobile Co. Ld. joint venture with Shanghai Automotive Industry Corp.

“The high number of small-car sales this year will cut into auto makers’ overall profitability,” says Dunne, reminding that Chinese producers are notorious for price cutting, which also reduces margins and profits.

CAAM data released earlier in the year reveals in the year’s first four months 19 major automotive groups posted average revenue declines of 10.7% and profit shortfalls of 27.9%. Only five auto makers saw profits increase, while nine reported a profit decrease and five more suffered losses.

Although few of the auto makers were identified, most appeared to be Chinese national companies, not foreign auto-making joint ventures, which Zeng says “are quite profitable, although their profit-per-vehicle is declining.”

Because cars with engines 1.6L or less accounted for 63% of first-half sales, it’s not surprising that profits were scarce or that China’s domestic producers, specializing in small cars, have been the main beneficiaries of the stimulus plan.

“The market share of national-brand passenger cars increased to about 31% in July, and long-term will gradually increase to around 40%,” Zeng forecasts. “More and more big groups like FAW (First Auto Works) and Dongfeng (Automobile Ltd.) are launching their own brands, with quality comparable to foreign brands and competitive with them.”

The base is low, but some car companies are increasing sales by more than 200% and some smaller makers are doing well, too, he says. “BYD (Auto Co. Ltd.) sales grew 180% to 205,190 units in the first seven months, which is unbelievable compared to one or two years ago.”

Adds Dunne: “In a country as large as China, with 1.3 billion people…it’s difficult to manage that momentum. There’s a concerted government effort to point people toward smaller, more fuel-efficient vehicles.”

J.D. Power foresees sales rising 21.4% for passenger cars and 35.2% for light-commercial vehicles to an all-time record 11.03 million units this year, and continuing to grow far less hectically to 16.6 million units in 2016.

“(Yet), after such good sales so far in 2009, the OEM managers I’ve talked with are worried about 2010,” Zeng says. “The banks loaned too much money this year, and the possibility of excessive purchasing capacity and loan defaults is high right now.”

He anticipates China’s total light-vehicle sales at about 10.7 million units for the full year, still an all-time record, rising to 11.4 million units next year. The sales potential is huge.

“Market demand in China is not replacement, but for first-time buyers,” Zeng says. “Car ownership is quite low – only 53 cars per 1,000 people in Shanghai and as few as 10-12 per 1,000 in inland provinces like Anhui. There is plenty of scope for growth. And 85%-90% of Chinese car buyers pay cash. Bank loans do not support car sales.”

Analysts agree the present growth pace cannot be sustained indefinitely. China’s economy and vehicle sales undoubtedly have to calm down a bit, but the country’s position as a present and future world power is not in doubt.

That was underscored in early September by World Bank Group President Robert B. Zoellick during his third official visit to China.

“Through its massive stimulus and strong lending program, China has contributed to the early signs of a global recovery by keeping its growth rate up,” he is quoted as saying.

“With growth in China now projected at close to 8% for 2009 as a whole, and signs of stabilization in many other economies in Asia and around the world, the chances of a truly global recovery have increased measurably.

– with Barbara McClellan