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China’s Car Boom Could Go Bust

Reining in sales in the name of clean air.

by on Mar.01, 2013

Ford CEO Alan Mulally during a recent trip to China. Ford's sales are booming but could slip if regulators curtail the Chinese market.

After a few stutters last year, China’s massive automotive market seemed to get back on track in January, sales surging 46% compared to year-earlier levels. Yet there’s growing concern that the good times won’t continue for long.

There are a number of reasons to be worried, including a still frail global economy, nagging regional issues that include an ongoing territorial dispute with Japan and declining foreign investment. Yet the biggest concern, it seems, may be China’s endemic and worsening problems with air pollution.

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That has already led Chinese regulators to call for a rapid switch to battery-powered vehicles. But with market demand lagging Beijing’s call, a growing number of observers fear the central government may soon put in place steps to curb automotive ownership.

A growing number of major cities, including capital Beijing and economic center Shanghai, have already put restrictions in place, such as monthly limits on new vehicle registrations – though such measures have generally been aimed at curbing traffic problems, rather than emissions issues.

A new report by Jun Ma, chief Chinese economist for Deutsche Bank, anticipates the government will take several steps that include “constraining auto ownership growth,” as well as “implementation of tighter emission/fuel-efficiency standards to reduce per-car emission by more than 80%; and promotions to encourage the greater use of Electric Vehicles,” according to a report from the bank, which declares the potential cuts “broadly negative implications for the global auto industry.”

That’s because foreign manufacturers, including familiar names like General Motors, Volkswagen, Ford and Nissan, dominate the Chinese market.  They’re also investing billions to expand production capacity.

GM, for example, had hoped to see sales in the Chinese market surge from around 3.5 million to 5 million around mid-decade. Ford, which got off to a late start in the booming nation is now pushing to double its own volume.  Nissan recently launched a new brand, Venucia, with its Chinese partner Dongfeng Motors, to target consumers in regions of the country that are just beginning to share in the economic revolution that has long been focused along the Pacific coast.

That’s a move a number of competitors are taking.  GM and its domestic Chinese partners launched the Baojun brand in 2011 to focus on markets outside of already traffic-choked cities like Beijing and Shanghai. Considering there are more than 200 cities in China with populations of over 1 million, that still leaves a lot of room for growth.

But, echoes a report on the financial research site 24/7 Wall St., “the most unanticipated problem for car companies, both foreign and domestic, is the rapid rise in what already was terrible air pollution in China’s largest cities. The trouble has caused a slowdown in the use of factories, which have high emissions of air pollutants, and has forced local governments to take cars off the road and restrict car use in some cities.”

Hyundai got a taste of the problem late last year.  With pollution levels literally running off the chart published by the U.S. embassy in Beijing, the Korean maker’s local assembly plant was one of many factories temporarily shut down near the communist capital.

But with automobiles seen as contributing at least 20% of the country’s air pollution problem – and growing as the national fleet of vehicles continues to grow – the government can no longer focus on manufacturing to bring the problem under control.

The Chinese auto market has been on a bit of a roller-coaster for the past year as government bureaucrats diddle with the economy to avoid the setbacks troubling many other parts of the world. Demand for new vehicles was hit hard when government tax credits expired and were not renewed as many observers had expected.

But January’s 46% surge in sales led to a collective sigh of relief by the auto industry. The question is how they’ll respond if well-connected insiders like Deutsche Bank’s Jun Ma are correct and the government decides to curb what is now the world’s largest automotive market.

Simply putting limits on sales would be the most draconian possibility, but there appear to be other options under study. “We also believe alternatives to volume limits that would be much less impactful are possible, such as a scheme to incentivize scrappage of the current, inefficient vehicle fleet,” and get owners of older cars with outdated emissions controls to trade in on newer models, something that could actually buoy the market.

At the very least, the battery-car size of China’s market could be in for a charge. “Embarrassed by popular outcry against air pollution the ‘size of three Californias’ that recently blanketed swathes of coastal China, governments in Shanghai and Beijing will mandate electric vehicles for government fleet vehicles and taxis,” Michael Dunne, a long-time China auto analyst based in Hong Kong recently wrote.

The capital city already offers free license plates, as well as a $19,000 rebate to private EV buyers. And that’s on top of federal incentives that rival the $7,500 tax credits offered here by the U.S. government.

The potential battery-car boom has led to a rebound in the stock of long-lagging BYD – in which Warren Buffett holds a large stake.

But whether the EV side might make up for curbs on conventionally powered vehicles remains to be seen.

Yet another possibility is that with restrictions on the domestic market, China’s automakers will increase their focus on exports. With local demand strong, that’s been of relatively little concern until now. Going forward, however, exports may be crucial to keep those Chinese factories running. Qoros, a new joint venture partially owned by China’s Chery, will show a new line of products at the Geneva Motor Show this month, with European sales slated to start in less than a year.

It could be the first of many brands to follow if Chinese regulators try to hold back their home market auto industry.

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