The Automobile Market in China

Alberto Pagliarini
China overcame the United States as the world’s largest automobile market in 2009. According to China Association of Automobile Manufacturers (CAAM), the aggregate volume of new automobile sales during 2010 (including both passenger and commercial vehicle) was 18.1 million units, representing a 33% growth rate over 2009 and a CAGR of 25.6% from 2006 to 2010. About three quarters of the vehicles sold (12.8 million according to JD Power) were earmarked for passenger transport, conferring China also the status of most important passenger vehicle market.
Automobile sales in China posted a remarkable CAGR of 20% from 1999 to 2008. Driven by stimulus policies, such rate literally boomed in 2009 and 2010, reaching 51% and 31%. However, According to CAAM, however, during 1H 2011 auto sales only increased by 4% with respect to the previous year, and they are expected achieve a moderate growth of 5% during the entire 2011 (JD Power).
Such expectation of cooling results from 3 fundamental factors:
1- The end of the tax benefits for car purchases (enacted in the wake of the financial crisis) which gave incentives to buyers purchasing a vehicle before the 31st of December 2010
2- The introduction of quotas for new car registrations in Beijing, Shanghai and Guiyang
3- The escalating inflationary pressures, which will eat into purchasing power for low-end cars
Nevertheless, the outlook for Chinese car sales is likely to remain a positive one (although at lower growth rates). After all, the passenger vehicle penetration rate is still of 70 units per 1,000 inhabitants, a fraction of that registered in most developed countries. While a lower penetration compared to nations such as the United States (450) and Germany (511) is easily predictable, this figure is also substantially lower than in other industrialized Asian nations such as Japan (325) and Korea (256). As GDP per capita grows in China, creating a larger middle class with higher disposable incomes, car ownership should continue to expand.
Buoyed by the growth of 2009 and 2010, automakers (both domestic ones and JVs) have invested heavily to increase production capacity. While in 2010 most automakers were operating at 100% utilization rate (and some at much higher rates), with new capacity coming on line and a slowing pace of growth, utilization will decrease and automakers will feel an uncomfortable pressure to cut prices. The research community expects the capacity of the 30 major automakers in China to grow at 19% CAGR from 2010-13, outpacing demand growth by approx. 10% per year. If such prophecies proved to be correct, Industry-wide utilization rates could fall from nearly 100% in 2010 to less than 80% in 2012.
This boom and bust cycle in the automotive industry is not a new or surprising phenomenon. China’s automobile industry, indeed, already experienced two analogous overcapacity waves over the past decade, also due to a high degree of fragmentation that makes supply in the industry rigid and unable to adapt to swift changes in demand. The first upward blossomed in 2002 (in the wake of China’s admittance to the WTO). Automobile demand peaked up sharply, far exceeding supply. Car makers’ profits achieved record levels in 2004, but were subsequently depressed when producers expanded the output base, thus triggering a ferocious price war. After two tough years (2005-06), the industry recovered in 2007, as demand picked up to absorb excess capacity. Subsequently, in September 2008 the financial tsunami hit the world, and the Chinese automotive industry suffered another setback, promptly countered by the stimulus packages enacted by the central government in early 2009. Due to the ensuing surge in demand and under-investment among suppliers in 2009, all major automakers faced significant capacity bottlenecks which, for many of them, have persisted until today. Automakers in China pocketed record profits in 1H 2010, thanks to large unit volumes and stable selling prices enabled by utilization rates stuck at 100%.
For the future, many insiders expect the premium segment to outperform the overall market. This is due, first of all, by the very nature of the high-end car segment, less sensitive to policy changes such as tax incentives and new car registration quotas. Furthermore, the wealth of high-income groups in China increases at rate much faster than average GDP growth, also because they can leverage investment options that are not available to the middle class or to poorer Chinese citizens. Emblematically, 70-80% of family savings in China are held in deposits whose yield is way lower than the current rate of inflation.