China:Gentlemen, kill your engines(huge overcapacity may lead to world-wide glut of cars)

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.

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.

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."

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.

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.

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.

"A harbinger of popping Chinese bubble."

This might simply be the popping of our own (western)Chinese bubble. As automakers from around the world rushed to fill the expected orders for import cars, China is showing that it would rather produce cars for it's own population.

They can allow the glut to occur, forcing a variety of auto companies to fade, then bail out the more prize facilities, continuing on with their own brands.

More and more Western businesses are discovering the true depths of Chinese inscrutability!

Every week or more often I get to say I am amazed that this or that is happening. Common sense told me that all these american manufacturers are gonna get screwed in china. After china has all the plants and know how they will make up a excuse to toss out the americans and they will cheat on copyrights and take over the industry.

I hate to say it and hate to see it but they deserve whatever happens to them.

Re #4

It is true that China wants to build their "own" industry, not more subsidiaries of multinationals. However, if they use this overcapacity to wean out Western companies, their collateral damage would be too high. They will have an economic bust at least for a while, which they may not be able to escape. Remember Tienanmen Uprising? That erupted because China is in a recession at the time. Imagine what will happen if Chinese economy really tanks, as S. Korea or Japan did. Things can get really ugly fast.

Re #6

Correction:

It is true that China wants to build their "own" industry, not ~~more~~ mere subsidiaries of multinationals. However, if they use this overcapacity to wean out Western companies, their collateral damage would be huge. They will have an economic bust at least for a while, which they may not be able to ~~escape~~ survive. Remember Tienanmen Uprising? That erupted because China is was in a recession at the time. Imagine what will happen if Chinese economy really tanks, as S. Korea or Japan did. Things can get really ugly fast.

Things can get really ugly fast.

And then the guys in charge in Peking say "So what? A few million dead people here or there don't signify".

foreign carmakers are required to enter into joint ventures with local, mostly state-owned companies

Required? State-owned?

"Free traders" meekly accept anything thrown at them by their Chi-com partners -- but when one U.S. citizen raises a question about transferring technology, capital, and jobs the "free traders" start screaming "protectionist!" "Doom and gloomer!" "Government interference!" "Kerry supporter!" "Socialist!"

Go figure.

I have to question some of your thinking there. The vast majority of protesters in TS were students. Students are the least likely to give a rats ass about recessions. Maybe you heard of theat little Anti-USSR stuff going on in Easern Europe at the time?

Also, China has historically been in it for the long haul. As others have pointed out, if they can get the expertise and the facilities for free(heck, even making money along the way) and suffer a slowdown for a couple years as the economies of the world dive, they would be happy. Because they have a HUGE built in market and then they would swoop in to capture a big % of the world market during the next upswing.

" Gridlocked traffic, unbearable air pollution and skyrocketing oil prices don't make the best advertisement for a new VW Polo."

But auto sales crash in China might just depress the price of oil, eh?

Remember Tienanmen Uprising

Remember what happened once the media was thrown out on their butts? What ever uprising there will be will be short lived, Beijing has no desire to see things grow out of control and wreck their plans. Their economy is expendable, so our their people, and so our foreign investors, but not their long range plans. They have pretty much all they need for manufacturing a more or less modern military. Any spare capacity that the fools of western companies happen to supply them with prior to closing the business down is just par for the course. That is probably why they haven't stopped the glut that is accumulating, the more rope the west gives them, the more people they can hang.

Also, Chines debt to GDP is 50% plus, this is totally unsustainable and the Chinese gov knows this, yet they allow it to continue to accumulate as much manufacturing capacity and capability. The leaders there are very shrewd for allowing this.

it's funny that you should ping me to this because the other day I was sitting in the C-Straits caffe and I was talking with a local gentleman about the number of cars in China and the fact that I have yet to see a junkyard anywhere for retired vehicles. However, he was quick to point out that the Chinese people have not been able to own their own cars for as long as Americans have and therefore the government has been able to adequately deal with the number of retired vehicles generated through offical usage. As it is now, people are not accustomed to the maintenance that usually goes with owning a personal vehicle and without an adequate infrastructure to support the service needed, there will be more junked vehicles to deal with in 10 years than they will probably be able to handle.

Not sure if I agree with him, but it certainly makes good sense.

Exactly!

The only reason foreign owned companies are required to undergo "joing-ventures" is that the Chinese or state owned company can learn to copy the technology used to produce the prodcute. The venture will flow smoothly until then and after that the Chinese will pull out the carpet and go into business for themselves.

Well, when I was last there, China didn't have enough roads for bicycle traffic. Believe me, it's a sight to see 20,000 people on two-wheelers coming toward you on the road. I can't imagine what kind of gridlock would ensue if those same folks were in Impalas. Rush hour wouldn't end until Monday. (Monday was the "weekend" in Nanjing).

So this "slowdown" may be just a delaying tactic until the government can lay down a few hundred thousand miles of pavement.

Then they will steal the technology and make cars. (And billions).

Its going to end badly for the US taxpayer, because if the company is an American one, and fails due to foreign government policies, they are fully insured through OPIC and you and me, to recoup their losses.

"The Chinese are much more prone to do business in a way that today Europeans and Americans do not accept - paying bribes and all kinds of bonuses under the table,"
--oil industry analyst Gal Luft

except maybe the free traders?

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