Chinese Auto Market

A recent Business Day article outlines overcapacity concerns in the Chinese car manufacturing industry. Sales have boomed as China’s auto market overtook the U.S in 2009 as the world’s largest due to the emerging middle class and rapid increase in per capita incomes. The demand for cars far exceeds supply at the moment.

This year, up to 17 million vehicles are expected to be sold – an increase of 25-30% after last year’s 46% surge. This has caused manufacturers to increase production at a rapid pace, leaving analysts seriously concerned. The auto market has huge potential in China, a country with a massive population but relatively low percentage of car ownership.

The article reports that international joint ventures do not hold enough current capacity to meet the huge demand, resulting in new investment decisions.
Nissan, Toyota, Hyundai, Volkswagen and FAW to name but a few, have recently announced openings of new production facilities in mainland China. This increase in the supply-side capacity of the car industry seems to be at risk of too much inward investment.

Some concerns of the National Development and Reform Commission, China’s powerful economic planning agency claims:

“Serious overproduction capacity will lead to negative market competitiveness, a loss in enterprise efficiency, factory stoppages and other problems.”

Perhaps this should serve as a reminder of elasticity of supply in a rapidly growing sector. As a general rule for the resposniveness of producers to changes in the price of their goods, if prices rise then so does supply. But we know that cars are a normal good. So long as your income is rising, you will purchase more. Which leads to our next point...

Forecasting is difficult in the auto industry and adding new plants takes time. Our readers will recall a previous blog on the devaluation of the yuan (see below). We would like to point out that just last week The People's Bank of China said it was raising benchmark rates by 25 basis points in an effort to curb persistent inflation. An increase in the interest rate is designed to slow investment. The Business Day article is evidence of this inflation. We could likely be seeing too much capacity in a few years when markets have cooled.

For more on the People's Bank click here.