Gentlemen, kill your engines
By Jamil Anderlini

SHANGHAI - Two weeks ago, in a beautiful display of dry banker's understatement, Morgan Stanley lowered its rating on China's automobile industry to "cautious" from "in-line". But "cautious" doesn't quite tally with the actions of the world's biggest auto manufacturers over the last year and certainly fails to capture the current mood that must pervade the Shanghai boardrooms of General Motors, Volkswagen and all the other car companies that have been pouring spectacular sums into the Chinese car market.

"Blind panic" might be a more apt description. Sitting in their corporate boxes at Shanghai's first-ever Formula 1 Grand Prix last weekend, the top brass of the auto-manufacturing world was probably praying that the spectacle would somehow inspire the masses to go out and buy themselves a Buick or a Passat.

Despite figures showing rising incomes and increased consumer spending, car-sales growth has evaporated almost overnight as the government continues its attempts to slow down the overheated sectors of the economy. China's National Passenger Car Association said car sales in August stood virtually still, compared with July, marking the fifth straight month of declining growth. This has been a massive shock to an industry that saw sales rise 75% last year and 62% in 2002.

Cooling the engines
The drop in sales is a result of the government forcing banks to slow down lending for big-ticket items like property and cars. In May, after the government's clarification of cooling measures, sales fell 20% from the month before.

With spectacularly inauspicious timing, the world's largest auto manufacturer, General Motors, announced in June that it was investing a further US$3 billion (on top of the $2 billion committed earlier) over the next three years to more than double capacity to 1.3 million vehicles and add 20 new models. The company also announced it was moving its Asia-Pacific headquarters from Singapore to Shanghai to be closer to what it called the "world's fastest-growing car market".

GM is probably better off than most of its competitors. Sales of GM cars actually rose 57% year-on-year in the first half and the company is hoping that the opening of its own auto-financing company in August (the first in China, according to GM) will allow it to circumvent the government's restrictions on bank lending.

Volkswagen, which has watched its share of the China market fall from 45% a few years ago to well under 30% now, has fared much worse. In August, VW's Shanghai plant saw year-on-year sales drop 19% to just 26,000, out of total nationwide sales of 163,263 for the month.

Meanwhile, total output reached 169,600 cars in August, adding to the already large inventories at factories and dealerships. While sales are flat, passenger-car production is up 25.4% for the first eight months of the year, according to China's statistics bureau.

With all the extra cars building up, production targets have been slashed. The government announced two weeks ago that it was launching an investigation into the downturn in the automobile industry and cut its overall production growth forecast for the year to 18% from 40% - from 2.82 million passenger cars to 2.39 million. Last year, production rose 83% to about 2 million cars.

Racing to the bottom
The reaction to falling sales has been painful for auto companies, but predictable. Prices of cars and other transport products dropped 13% from a year earlier in August. Cutting into margins is becoming widespread as companies begin what many fear will be a race to the bottom. Prices for low-to-mid-range sedans were already falling in 2003 by an average of 7%, but the latest drops have been steeper and have had an unexpected and unpleasant effect.

Savvy consumers all know there is overproduction and they are putting off buying in anticipation of further price cuts. This has caused sales to drop even more. "Everyone's waiting until Chinese New Year to buy. They know that's when all the new models come out and that the prices will continue to fall," Paul French, an economist at Access Asia, told Asia Times Online. He said prices still have a long way to go. "The price of a new Cadillac in Shanghai is about $60,000 while the same model in the US sells for about $30,000."

Flashing yellow lights
Actually, many people living in China could have instinctively guessed that the auto boom was coming to an end. You only have to look out of the window in Shanghai, or especially in Beijing, to know that last year's growth rates in car production and sales were unsustainable. Gridlocked traffic, unbearable air pollution and skyrocketing oil prices don't make the best advertisement for a new VW Polo.

One of the stated targets of the central government's economic cooling measures has been the automobile industry. The official government warnings of overinvestment and future overcapacity in car factories were coming out as early as August 2003. A year ago almost to the day, the State Development and Reform Commission held a meeting in Kunming in southern Yunnan province to discuss industrial development and deputy chairman Zhang Guobao said there had been blind investment, chaos and disorder in the steel and car industries. A public statement like that could only mean that the government was planning to intervene.

The scary thing is that even though at least 30% of the existing production capacity in China is lying idle, enormous expansion plans by all the major players are set to increase that capacity drastically. It's easy to see why the leaders in Beijing began to worry when faced with the sheer scale of global auto makers' intentions.

Fields of dreams
Even the most optimistic of sales-growth figures pale in comparison to what is in the pipeline. Besides GM's $3 billion injection, Volkswagen has pledged about $6.65 billion to double its annual capacity to 1.6 million cars. It is hoping for sales of one million units in 2007. With VW's total sales for the last three months coming to just 110,000, that target looks a long way off.

GM's rivals from Detroit have been slower off the mark. Ford announced at the end of last year that it was planning to invest $1.5 billion with its domestic partner over the next few years and aimed to boost annual production to 150,000 units, while DaimlerChrysler pledged US$1.2 billion last year to build Mercedes and Chryslers with its partner, Beijing Jeep.

The Japanese and Koreans are not to be outdone either. Toyota, Hyundai and Nissan announced a combined investment of $3.4 billion in 2002-03, which would add an annual production capacity of two million units by 2010. Kia is also installing new production lines and opening new factories in China. Mazda, which is controlled by Ford, aims to triple sales to 300,000 by the end of the decade and Honda Motor said it intends to increase its annual capacity from 120,000 to 410,000 next year or in 2006.

Domestic car makers are also under pressure to boost market share. First Auto Works (FAW), the country's largest indigenous producer, was targeting an 11% increase in output this year to 1 million units and even the upstart Geely, China's largest car manufacturer with no foreign ties, was hoping to double output this year to 160,000 units. With the slowdown in sales, the company has downgraded that target to 120,000.

This far-from-comprehensive list alone adds up to an annual 6 million passenger cars rolling off production lines within the next few years. By one estimate, Chinese factories will have the capacity by 2007 to build twice as many cars as the country's consumers will be buying. That means intense competition and consolidation between foreign carmakers and the 123 domestic manufacturers, many of which have foreign partners but only two of which have had annual sales of more than half a million. About 75 of these producers record annual production figures in the vicinity of 1,000 cars.

Currently, about 16 companies generate 90% of China's vehicle sales and auto executives expect that figure to shrink to half or less in a couple of years.

Export nation
So what is going to happen if sales don't suddenly pick up? All that excess capacity will either have to be written off or else China will pretty quickly become a car exporter.

The government actually has plans to turn China into an internationally competitive car-exporting base and to that end, foreign carmakers are required to enter into joint ventures with local, mostly state-owned companies. The multinationals dominate the industry but Beijing aims for domestic automakers to own half of China's auto production and for 40% of production to be exported by 2010.

In fact, while the world's auto giants have been pouring cash into China's market, some domestic producers have already been quietly seeking to expand overseas. BYD Auto, which is owned by the world's second-largest manufacturer of rechargeable batteries, is exporting cheap compacts to Syria and Sudan while Geely sends its cars to the Middle East and Mexico and hopes to be selling its Uliou sedan in the US by the end of the year.

We could soon see the day when Shanghai Buicks share a Detroit showroom with the latest Geely.

Jamil Anderlini is the former editor of China Economic Review. He can be reached at Jamilanderlini@sinomedia.net. 

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