Outlook for China’s Automotive Market

Though the year ahead is widely expected to be “China’s most difficult year”, China’s automotive market remains on a torrid pace for growth. Government efforts to slow the economy, sky-rocketing fuel prices, and rising uncertainty with the overall economy have done little to deter consumer enthusiasm for buying new vehicles. This may change as we move deeper into 2008, as the challenges that the market faces increase, but for now things appear solid.

After considering economic and market factors, we expect China’s automotive market to continue to expand this year, but at a slower pace than 2007, and at a slower pace than was achieved in the first quarter of 2008.

According to Meg Sunako, Chief Asia Economist at J.D. Power Forecasting, light vehicle demand expanded at a seasonally adjusted annualized rate (SAAR) of 9.5 million units in the first three months of 2008, which if sustained, would represent a 17% increase over the 8.1 million units delivered in 2007. The 2.85 million units of light vehicles sold in China during the first quarter represents a remarkable 18% increase over the 1.94 million units sold in the same period of 2007.

We believe that the market will finish the year somewhat below these early indications. We expect vehicle demand in China to grow to 9.2 million units in 2008, still an impressive 14% increase over 2007.

Of concern is an increasingly challenging business environment in China. Chinese premier Wen Jiebao was quoted in March as saying 2008 would be “China’s most difficult year”.

Among the challenges facing China is an overheating economy. China’s economy grew by more than 11% in 2007, a pace most analysts and policymakers recognize as unsustainable and potentially destabilizing.

Inflation is a potentially major problem in China, and is cited as the number one for the country according to comments made by various policy makers. And through the first two months of 2008, inflation achieved a worrisome rate of 9%.

Along with the increasing apprehension about inflation, China is – somewhat paradoxically – in fear of a slowdown in export demand to the United States. A slow down in exports might ease inflation, but would also threaten factories and jobs along China’s Eastern seaboard. Industrial companies in China’s coastal manufacturing regions are already reporting shrinking margins as China’s currency strengthens, and as energy costs, raw material costs, and wage rates edge higher.

China has taken several steps to slow its economy; this includes raising interest rates six times in 2007, and raising the mandatory bank reserve requirement a like number of times, most recently to a remarkable 15% of deposits.

Based on the combination of these factors -- tightening economic policies, high inflation and the weakening export sector – we expect consumer demand to begin to slow during the course of 2008.

In the long term, however, we expect China’s vehicle market to continue to grow. By 2015, we expect annual light vehicle sales to reach 17.3 million units. Of this total, we expect the market to be comprised of 12.4 million passenger vehicles and 4.9 million light commercial vehicles.

Among passenger cars, the compact car segment enjoys the strongest growth trend. Up 36% in 2007 and again up 28% in the first quarter of 2008, the compact segment is proving to be the most popular segment and most important to manufacturers in China. Sales growth in 2007 was helped by several new model launches, including the launch of the new Toyota Corolla and a strong performance by VW.

Our expectation is for this segment to come under pressure from the sub-compact segment, as the price of vehicle operating costs -- including increasing fuel prices -- move buyers to more fuel efficient cars. So far in 2008, however, the migration to smaller cars has not happened, pointing to the important role cars play in defining car buyer’s personality.

Growth in the subcompact segment in 2008 will be supported by an expected eleven new model launches. Chery, Great Wall and JAC are releasing models in the first quarter.

Models from Changfeng, Toyota, Ford, Hyundai, Mazda, Peugeot, and Skoda are all also due to be released throughout 2008, among which the Ford Fiesta, Mazda2 and Toyota Yaris models are expected to perform best.

The mid-sized car segment has grown strongly in recent years and is expected to outperform the market in 2008, with volumes rising by 18.6% to 1.13 million units. This segment is expected to again be led by the Toyota Camry, followed by the VW Passat and redesigned Honda Accord.

Growth in the mini-car market has been sluggish in comparison with other passenger car segments, with volumes rising by 4.4% in 2007 to 344,034 units. Mini-cars represented just 6.3% of the passenger vehicle market last year. In the short term, new models will help support volumes, including the launch of Great Wall’s Peri, BYD’s F1 and Chery’s A1 models this year.

The mini car segment remains dominated by Chery with its QQ model, while Chana has been expanding aggressively since last year with its Benben model and a second model is set to follow in 2009.

Demand for luxury cars in China has seen explosive growth since 2004. The segment grew by just under 30% in 2007 to 194,000 units.

Demand for luxury cars will continue to outperform the overall passenger vehicle market once again in 2008, with volume growth of 21% to 234,000 units. Strong demand for locally produced Audi and BMW brand vehicles, and imports from Lexus will drive demand. By 2015, the luxury car segment is forecast to double in size to over 521,000 units.

China’s SUV market growth picked up dramatically in 2007, with volumes rising by almost 46% to close to 433,000 units against 297,000 units in 2006.

Compact SUV models accounted for 53% of total SUV segment sales. The best-selling compact model was the Chery Tiggo – with over 50,000 sales in 2008 – followed by the Honda CR-V and the Hyundai Tucson, netting 45,707 sales and 44,731 sales, respectively. The Toyota Rav4, the Chevrolet Captiva and the Kia Sportage, as well as recently launched models such as the Mitsubishi Outlander will support segment growth in 2008.

In sum, despite mounting challenges within China’s business environment, China’s automotive market will continue to grow across all segments. Expect the growth to slow from its current pace, but continue to expand at rate to make most markets envious.