China in Transition

Chinese Automobile Industry Facing Overcapacity
- Japanese automakers required to change their strategy

Chi Hung KWAN
Consulting Fellow, RIETI

On June 1, the &China Automobile Industry Development Policy" was released for the first time in a decade, setting the goal of cultivating the China automobile industry into a pillar industry for the national economy by transforming China into one of the major automobile production countries in the world by the year 2010. Following that announcement, the "Beijing International Motor Show" was held in grand style on June 10-16, where automakers from Japan, the U.S. and Europe set up gorgeous displays of their new models of high-class cars, targeting the emerging class of "new rich" in China. However, despite makers' optimistic views, signs of overcapacity in China's automotive industry have already become apparent. So, it is doubtful whether this is the appropriate time for Japanese makers to rush into China.

Through its entry into the World Trade Organization in 2001, China has rapidly expanded its automobile production to 4.44 million units (up 36.6% from the preceding year) in 2003, replacing France as the world's fourth largest automobile producer. Contributing to this advance is the increasing supply that has stemmed from the building-up of facilities, by foreign makers, including Honda, Toyota, and Nissan from Japan. This is also helped by growing demand from the middle classes and favorable economic conditions. The major goal for foreign automakers expanding into China is to gain access to the Chinese market rather than to cut production costs. One may also access the Chinese market by exporting to China from overseas, but in order to avoid trade barriers such as import tariffs, foreign makers are forced to produce locally. Under the current conditions, where China's domestic market is insulated from global competition thanks to the existence of high tariffs, many foreign automakers producing locally have earned high profits.

However, high profits in the past are unlikely to be sustained in the future. One of the reasons for this is that at its accession to the WTO, China committed to reduce the tariffs on automobiles to 25% by the year 2006. That will raise concerns over the tough competition between domestic and imported cars. Secondly, the world's major automakers' aggressive production strategies, as well as the participation of new domestic players, will sooner or later result in overcapacity, raising pressure to cut prices. Indeed, in May 2004, automobile prices were already down by an average of 9.2% from the same month of the preceding year. Thirdly, the Chinese economy has entered a phase of adjustment as a result of recent tightening measures taken by the government to cool down the overheated economy. In fact, China's auto production dropped for two consecutive months to 215,100 units in May, down 12.2% compared to the peak month of March (China National Statistics Bureau). Sales took an even bigger plunge, resulting in a rapid increase in unsold stocks.

Unfortunately, carmakers will find it difficult to shift to exporting from China in case domestic demand continues to falls. Although the new "Automobile Industry Development Policy" includes a provision that permits foreign makers specializing in exports to control more than 50% of the stakes in an automobile joint venture with a Chinese partner in order to promote exports, handicaps such as the absence of economies of scale and development capabilities, as well as an undeveloped parts industry, have hindered the international competitiveness of China's auto industry.

With Japanese makers bringing with them technology and funds when investing in China, these handicaps might be somewhat relieved. Still, other major obstacles have to be cleared in order to export automobiles from China. First, while sales in China are protected by import restrictions imposed by the Chinese government, exports from China face import restrictions imposed by trading partners. In particular, a major obstacle to promoting exports from China when trading with developing countries is import tariffs, while environmental standards will act as a major barrier when trading with developed countries. Second, China's international competitiveness to a large extent depends on the wage level as well as the foreign exchange rate of the yuan, which are likely to rise in response to the increasing productivity of Chinese industries. If China's auto industry achieves international competitiveness under the current exchange rate, it will create a huge trade balance surplus, with the result that China will be pressed to substantially revalue the yuan in order to decrease it. Japanese automakers have to take these risks fully into consideration when they pursue their strategy of exporting from China.

June 30, 2004
Related article

"On China Becoming a Major Auto Power - The need to enhance international competitiveness," China in Transition, June 20, 2003

"Japanese Carmakers Shouldn't Race into China," China in Transition, June 21, 2002

June 30, 2004