China’s Exuberant Economy Driving Car Sales

Automotive experts see nothing irrational about China’s exuberant growth; past, present or future.

This year, the World Bank expects China, with economic growth of 9.5%, to replace Japan as the world’s second-largest economy. This follows the country’s move past the U.S. last year to become the world’s largest automotive market.

The road to the future for passenger-vehicle sales in China undoubtedly will continue to be marked by twists and turns. Yet, it is expected to continue its unapologetic climb from a total 600,000 units in 1999 to a nearly four-fold jump to 2.38 million in 2004 and a more than a three-fold increase to 8.72 million in 2009.

Despite a startling 79% surge in first-quarter 2010 passenger-vehicle deliveries to 2.92 million, there’s no consensus on what the full year holds, although it appears to look good by any yardstick but China’s.

“In 2010, we see 10% growth in passenger-vehicle sales to 9.6 million units,” says Tim Dunne, an industry expert with J.D. Power & Associates, who thinks the impact of bank-lending may be exhausted by midyear.

Not included in the count are the popular micro-vehicles made by SAIC-GM-Wuling Automobile Co. Ltd., Changhe Automotive Co. Ltd., Changan Automobile Ltd. and other domestic auto makers.

The China Automotive Association of Manufacturers reports industry inventories in March hit 500,000 units, up about 50,000 from February. Average dealer stock was an estimated 75-day supply, suggesting hyper-growth may be slowing.

But John Zeng, a senior industry analyst with IHS Global Insight in Shanghai, is optimistic. “The growth rate this year in the passenger-car market will be 19% to 20%,” he says.

“Demand is picking up quickly in inland areas, and every OEM in China has announced an aggressive expansion plan. We estimate passenger-car capacity will increase from around 11.8 million units in 2009 to about 21 million in 2014.”

Market share of national-brand cars climbed from 25% in 2008 to about 30% in 2009 and forecast at 33% for 2010.

What’s attracting attention these days are the tantalizing shifts of major importance, geographic and economic, now under way in China.

“China’s emergence as an economic power was based on exports,” says Dunne. “But now the government is encouraging more internal growth and more consumer-spending, rather than depending on exports.”

Adds Zeng: “The government realized relying on exports for economic growth was dangerous and unsustainable, so they have been trying to boost domestic consumption.”

Even as exports slumped last year, China managed to escape the worst of the global recession with a massive economic pump-priming program that included RMB9.6 trillion ($1.4 trillion) in bank loans and RMB3.6 trillion ($580 billion) in infrastructure development.

The stimulants worked so well, triggering a real-estate boom and soaring stock prices, that Beijing leaders now are trying to cool an over-heated economy to avoid an asset bubble and rising inflation. The brakes have been put on banks, with an increase in interest rates, reserve requirements, lending quotas and, in some cases, a temporary halt to loans.

Still in place is a concessionary purchasing tax of 7.5% on cars with engines 1.6L or smaller, up from 5% in 2009 but less than the 10% charged earlier, and generous subsidies for buyers who swap old vehicles for new, more fuel-efficient ones.

The apparent contradiction between sweetening and tightening is not that unusual, says Dunne. “For the Chinese government, managing the economy is a constant balancing act between too much growth and not enough growth.”

China’s vast interior is another target of Beijing’s balancing act, where much of the new infrastructure spending has been aimed to attract investment and industry, provide jobs, raise incomes and expand opportunities.

“China’s rural population of 700 million people is the next frontier for companies already established in urban China,” according to “The Keys to the Kingdom – Unlocking China’s Consumer Power,” a new report from the Boston Consulting Group (BCG).

Looking at China’s automotive market by regional sectors, Zeng says, “the market share of Tier 1 cities, such as Beijing, Shanghai and Guangzhou, has dropped from nearly 50% in 2004 to around 37% or 38% today. New demand for vehicles is coming from Tier 2 and Tier 3 cities, and we can clearly see economic growth increasing in inland regions.”

Car ownership is only 53 per 1,000 people even in cosmopolitan Shanghai, and as few as 10-12 per 1,000 people in inland provinces, the lower end of the automotive market, he notes.

“The average blue-collar worker there earns around RMB1,500 ($220) a month, about half the level in the coastal areas,” Zeng says. “Some labor-intensive industries are switching their production base to the interior.

“Lower wages are a cost advantage. Living is much cheaper. And new high-speed trains connect to the coasts. For example, trains running 350 km/h (218 mph) have cut travel time from Wuhan to Guangzhou from 17 hours to three.”

As the domestic market broadens, competition is expected to become even sharper for all major auto makers selling cars in China. Coming up fast on the inner rail are the national car producers, many of them healthy and hungry for more sales, strengthened by government help.

For example, Tomoo Marukawa, an associate professor at the University of Tokyo, says Chery Automobile Co. Ltd. was given free land by Wuhu City; an interest-free, 10-year loan from the State Development Bank; and preferential loans from China’s Export-Import Bank.

“The market share of the national-brand cars increased from 25% in 2008 to about 30% in 2009 and for all of 2010 will be around 33%,” says Zeng who foresees their market share rising to as much as 38% or 40% in the medium term, between 2015 and 2017.

“The quality gap between Chinese national brands and foreign brands is shrinking year by year.”

Five Chinese brands – Chery, BYD, Geely, Xiali and Great Wall – are among the top-20 sold in China. Their specialty, sub-compact and compact cars, now account for nearly two-thirds of the car market.

“As the frontier of automobile sales has apparently moved toward the poorer population, manufacturers who can make cheap and good cars will get the leadership of the industry,” Marukawa predicts.

Says Dunne: “Some foreign makers are starting to de-content their smaller cars to reduce cost and prices and compete in the lower market segments, though not in the micro segment where vehicles sell for $4,000 to $5,000.”

Although there is no agreement on how fast or how far the market will grow near-term, J.D. Power & Associates’ recent report, “China Automotive 2015: The Cost of Opportunity,” calls for sales of passenger vehicles, including cars, SUVs and minivans, to jump to 13.55 million units in 2015, up more than 55% from 2009.

However, getting there will not be easy, given the challenges and obstacles in the way.

The World Bank’s warning about the need to contain inflation, plus international pressure from trading partners, is building for Beijing leaders to let the under-valued renminbi appreciate and end an unfair advantage for Chinese exporters.

The J.D. Power report warns about special problems facing auto makers, including a multiplicity of brands (more than twice the number in the U.S.) that is generating hyper-competition and an adverse impact on pricing and profit margins, plus the need for consolidation to reduce the number of marginal players.

“Today, some 50-plus auto makers are producing more than 90 brands in China,” says Dunne. “A lot of auto makers in China made record profits last year. Without the stimulus, they would have been badly hurt. Underutilization of capacity will remain a problem.”

Chinese passenger-vehicle plants ran at only 70% of capacity in 2009, he says. A typical plant in the U.S. or Europe that must run at 80% of capacity to breakeven. And although there are variables, many industry experts believe the 80% rule applies to China, as well.

For years, Beijing has been trying with limited success to reduce the number of Chinese vehicle producers, but political resistance remains strong.

“Consolidation should be driven by the market, not the central government,” Zeng says. “Every provincial government wants an auto maker to push the local economy and is offering many incentives to attract them.”

But, he concedes “some of the small, unprofitable companies with low sales volume are not going to survive.”

Dunne says about 20 small car makers currently account for a 21% share of the market. “That’s not sustainable, and a shakeout is already under way,” he says.

“There are dozens of small auto makers on the periphery, selling only 20,000 or 30,000 vehicles a year, which are being folded into larger automotive groups like those of FAW, Shanghai (Automotive Industry Corp.) and Guangzhou (Automobile Co. Ltd.).”

Yet consolidation, by any means of attrition, likely would leave far too many small vehicle producers still in business.

“Considering the growing market and the strong wish of local governments to have an auto industry of their own, the number of auto makers will not shrink drastically,” Marukawa says.

Although assorted problems still may bruise the industry here and there, experts believe they barely will tamp the brakes, given the momentum provided by the vigorous growth of China’s economy and growing personal incomes.

Between 2010 and 2020, the BCG study expects China’s population to expand from 1.339 billion to 1.407 billion and per capita gross domestic product to grow in nominal U.S. dollars from $4,210 today to $16,290.

In that decade, BCG concludes the number of Chinese households will increase from 202 million to 262 million. Households with incomes from RMB60,000 ($8,820) to more than RMB200,000 ($29,400) will have more than doubled from 58 million to 133 million.

The BCG study emphasizes that “overall consumption levels begin to increase significantly when annual disposable income reaches RMB60,000 ($9,000) per household, which is the bottom of the middle-class segment.”

The authors of the study also say a dramatic shift in the geographic distribution of consumer spending power is under way in China. “The middle classes are expanding out beyond the largest cities more rapidly and in greater numbers than any market has ever witnessed.”

Because China is so large and diverse, there is no agreement among experts about how much income a Chinese household needs to be a first-time car buyer. But Dunne thinks RMB60,000 “is in the ball park.” Marukawa believes RMB50,000 ($7,000) may be enough.

“The generations in China are tied quite closely together, which influences car-buying behavior,” Zeng says. “The older generation may not own a car but wishes to see their children have one. So when a young couple wants a car, they normally get significant help from their parents.”

With the world’s largest population steadily becoming more affluent and more accustomed to a fuller life, it appears China’s exuberant growth will be a difficult habit to break.