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Despite solid demand, China’s auto market may be overheated

Most executives of China’s carmakers interviewed during the Guangzhou international auto show last November were bullish about the market in 2010. Of about 45 senior executives interviewed by local automotive Internet portals, 78 percent, or about four-fifths believe that China’s market growth in the new year would remain in double digits of 15-25 percent.

Automotive executives have every reason to be optimistic. China saw a new monthly sales record in November of 1.34 million, up 96 percent from the same month in 2008. It was the 9th consecutive month since March 2009 that sales exceeded 1 million units. In the first 11 months of 2009, China sold a total of 12.23 million new vehicles, up 49.7 percent compared with a year ago.

As December is usually a peak month in the year, sales may very well set yet another record and reach close to 1.5 million units as consumers would rush to purchase economy cars in an effort to take advantage of the 5 percent sales tax. This preferential sales tax for passenger vehicles with engines of 1.6L and smaller ended on December 31 and goes up to 7.5 percent in 2010. Total sales in 2009 are therefore expected to reach 13.6 million units.

The optimism reflected by OEM executives is in sharp contrast to their pessimism at the beginning of last year, when most of them had hoped to see a market growth rate of 10-15 percent for 2009 at best.

Many executives and analysts believe that the explosive growth last year was driven by a fundamental solid demand from China’s growing number of consumers especially in Tier 2 and Tier 3 cities who can now afford to buy automobiles. The 50 percent growth rate in sales last year was normal, some argue, because half of it should have applied back to 2008, when “consumers were scared by the economic downturn and decided against spending.” The high growth rate in 2009 reflects the release of consumer confidence, they say, their purchase decisions had been withheld in 2008.

To better understand the market performance in 2009, we should not, however, underestimate the leverage of the aggressive stimulus policies adopted by the central government in driving market demand, which include subsidies for rural residents in purchasing smaller automobiles, halving the sales tax of 1.6L and smaller passenger vehicles from 10 to 5 percent and vehicle recycling incentives. One analyst believes that the sales tax break and other stimulus policies have helped generate added sales of at least 1-1.5 million units. 

This has led some OEM executives, plus a number of dealers, to voice their serious concern about the possibility of an overdraft in consumer spending in the past year. About one-fifth of the interviewed executives believe that growth in 2010 may fall back to single digit if government stimulus policies discontinue.

Given the size of China’s vast number of consumers, nobody would doubt about a solid and growing demand for automobiles in the near future as the country’s economy pushes forward and per-capita income rises. But in the words of one of the executives interviewed, an annual growth rate of over 30 percent for China would be disastrous: “I do not believe that we can sustain an annual growth rate of 30 percent. It would mean 17 million units in 2010 and 22 million in 2011. That would create a huge burden on our energy resources, transportation, environment and society as a whole.”  He predicts that China’s market in 2010 may grow at around 5 percent.

The concern about an overheated market with overdraft spending has recently been addressed by the State Council, China’s cabinet, which has decided to raise the sales tax of 1.6L and smaller passenger vehicles from 5 to 7.5 percent as of January 2010. Decision makers are clearly worried about the adverse effects of an exploding automobile market on energy consumption, the environment, traffic gridlock and lost revenue. When the State Council adopted a series of stimulus packages in the Automotive Industry Readjustment and Revitalization Plan released earlier last year, it had hoped to stimulate automobile demand so as to maintain an average annual growth rate of 10 percent in the three years from 2009 to 2011. Nobody had expected to see a whopping 50 percent sales growth in just one year.

The government’s recent decision to raise sales tax for economy vehicles has a clear purpose of trying to cool off the automobile market. Other policies in favor of fuel-efficient, new energy and independently branded vehicles are also expected to be released in 2010, which will affect the country’s vehicle demand structure. China’s automobile market in 2010 is therefore expected to slow down considerably. From a long-term point of view for a stable and sustainable development, this would be good news for the industry and society as a whole.

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