China’s waning stimulus spells trouble for the world’s biggest car market

Consumer demand

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The blog’s latest post for the Financial Times, published on the BeyondBrics blog is below.

By Paul Hodges of International eChem

China autos Aug14China’s July lending level of just Rmb 385bn ($62.6bn) has surprised financial markets, which were expecting an increase in stimulus. But bigger surprises may lie ahead.

The strong link between lending and passenger car sales suggests we may be about to see major changes in the world’s largest car market.

The key to forecasting China’s auto demand since 2008 has been the level of bank lending, as the chart above shows.  This was critical in making China the world’s largest auto market.  Official data shows average disposable income was just Rmb 10,025 ($1626) in H1 2014, making it impossible for most people to buy a car out of income:

  • Purple period, 2008, saw auto sales of 600,000/month and lending of Rmb 400 billion/month
  • Blue period, 2009, of panic stimulus saw auto sales increase 50% and lending treble at one point
  • Black period, 2010-2013, was more stable with auto sales at 1.4 million/month and lending Rmb 600 billion/month

But the Brown period, 2014, may turn out to be a year of two halves.  H1 saw auto sales at 1.6 million/month, and lending at Rmb 900 billion.  But July’s reduced lending suggests the rest of H2 may well not match July’s 1.3 million car sales.

The linkage is confirmed by data from China’s Banking Association, which reported that direct retail loans to customers rose to Rmb 195 billion in Q1 2014 from Rmb 1.3 billion in 2005, and wholesale lending to dealers rose from Rmb 66.8 billion from 2.6 billion over the same period.

China’s auto association has already warned of a potential slowdown in the commercial vehicle market, “We believe the economy hasn’t shown obvious signs of improvement in the second half.  It’s hard to say whether more local governments will issue restrictions this year but this is definitely one of the risks we have to take into account.”

It seems most unlikely that China will simply abandon its support for the auto industry, given its importance for job creation.  But the nature of this support may well change, making past performance an unreliable guide to the future.

One sign of change is that many more cities are introducing purchase restrictions on new car sales to reduce pollution.  Beijing, for example, will only allow an extra 400,000 cars on the road between now and 2017, for a total of 6 million.

A second sign is the decision to strip most officials of their government car, and instead provide an allowance of $80-$210/month, depending on rank.  This is further bad news for overseas brands, which have held 80% of this $675 billion market.  Audi, GM, Chrysler and Mercedes are already under investigation by government anti-monopoly regulators.

A 3rd challenge is that China now has 137m cars on the road due to its recent hectic pace of sales expansion:

  • Used car sales will start to become more significant for the first time
  • Their volume is expected to double from just 5m/year last year to 10m next year
  • Equally, of course, new domestically-oriented markets for servicing and maintenance will also develop

This will add extra competition for new car sales, at a time when dealer inventory in June was already at a 12 month high, with some now holding more than 5 months stock.

The final challenge relates to pollution.  The government currently plans to take 6 million high-polluting cars off the road this year.  Whilst we can assume it will subsidise their replacement, it seems likely that support will be focused on the use of electric cars, with refuelling costs set to be 30% below gasoline prices.

A further sign of this new policy is the news that electric cars will be mandatory for official routes in urban areas, with hybrids provided for areas of extreme cold.  And subsidies (including exemption from the 10% vehicle tax) will only be offered for cars costing up to $29,000.

Investors, car manufacturers and their suppliers will need to move fast to realign themselves with this new direction.

In the past, companies could profit from selling high-priced cars to government officials and those benefiting from the wealth effect created by China’s property bubble.

In future, as GM have confirmed, companies need to refocus on the low-cost market.  This means producing cars to sell for $7,000 outside the major cities, where ownership levels are still relatively low.  Equally important will be the ability to offer electric and hybrid vehicles within the government’s new price limits.

 

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