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Auto prospects tied to economic reforms
July 22, 2013, Monday
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THE auto market seems to have another good year. In the first half of 2013, wholesales of passenger cars made in China increased by 18 percent from a year before. However, we believe that the growth rate will decrease to about 10 percent until the end of the year, mainly because dealers face a hard time getting bank loans and because car demand will decrease once the size of the wealth management products sector decreases.
Compared with last year, the pressure will not come from the luxury end of the market. Imports fell 8 percent in May from a year before. Import dealers have high inventories at an average of 80 days and have decreased their orders.
This time, BMW, Audi and Mercedes will exert less pressure than last year. The US premium market is back at the level of 2007, and, from the corporate point of view, a better geographical spread is preferable. Many car buyers in the US are probably Chinese anyway, since Chinese dominate the market for houses priced at US$1 million right now and many of these Chinese families will buy expensive cars as well.
The average dealer inventory for many brands exceeds the danger level of 45 days. The average for foreign brands stands at only 42 days, so that we don't see an immediate problem. But the average inventory for dealers of Chinese brands stood at 61 days in May, with brands like Geely reaching 81 days.
Dealerships presently find it difficult to keep or increase their credit terms with banks. The situation becomes more severe as inventories rise. Many Chery dealers are going down that road already, with 27 of them closing or switching to other brands in the first quarter of this year.
The success of the wealth management products has steered many households away from bank deposits, leaving banks with less liquidity for lending. Most loans are now channelled through "shadow banking," which are fuelled by wealth management products to a large extent. Loans from trusts come with interest of 20 percent a year, a rate taken up only by companies with their backs to the wall. It is not a rate a car dealership, for example, could afford for long.
We see the liquidity squeeze in June as a sign that the new government really intends to change the structure of the economy.
The squeeze sent a message to banks to reduce their exposure to wealth management products, entrusted loans and bankers' acceptances and return to lending under the stronger, regulated part of the financial system. We expect that the reserve ratio for banks will be decreased and wealth management activities will be required to appear on banks' balance sheets.
Moral hazard
However, this strategy will work only if households are informed that wealth management products don't have an implicit guarantee by the central bank. The bailout of the failed product sold by the Huaxia Bank in December 2012 has created a moral hazard.
Wealth management products currently have an average annualized return of more than 5 percent, compared to savings deposits that yield only 3 percent. Some products have an annualized return of 9 percent. We explain part of the strong demand for cars by these profits because most Chinese households are target savers.
Another portion of returns went into demand for housing, which has seen rising prices again after being depressed from July 2011 to late 2012. Once wealth management products become less prevalent and deposits become the norm again, the demand for cars will decrease, especially if consumer inflation rises above 3 percent.
The effect of lower demand and better credit terms for dealers won't likely be felt until the last quarter of 2013.
Economic restructuring would generally lead to lower car demand in the short term. That could lead to the exit of certain Chinese original equipment manufacturers and other "zombie" companies mainly kept alive by subsidies from their local governments.
Real estate could take a hit, along with about 30 related industries. Overcapacity in those industries would be eliminated. There would probably be some quantitative easing in the form of lower reserve ratios, but flooding the market with too much money could lead to inflation in 2014.
Local governments would have to tighten their belts and could afford only lower levels of new infrastructure, which would lead to even more pressure on the construction industry. The restructuring of the economy could take years. If policymakers follow the current plan, the economy would be much more stable and demand for cars would sustainably grow for decades to come.
Compared with last year, the pressure will not come from the luxury end of the market. Imports fell 8 percent in May from a year before. Import dealers have high inventories at an average of 80 days and have decreased their orders.
This time, BMW, Audi and Mercedes will exert less pressure than last year. The US premium market is back at the level of 2007, and, from the corporate point of view, a better geographical spread is preferable. Many car buyers in the US are probably Chinese anyway, since Chinese dominate the market for houses priced at US$1 million right now and many of these Chinese families will buy expensive cars as well.
The average dealer inventory for many brands exceeds the danger level of 45 days. The average for foreign brands stands at only 42 days, so that we don't see an immediate problem. But the average inventory for dealers of Chinese brands stood at 61 days in May, with brands like Geely reaching 81 days.
Dealerships presently find it difficult to keep or increase their credit terms with banks. The situation becomes more severe as inventories rise. Many Chery dealers are going down that road already, with 27 of them closing or switching to other brands in the first quarter of this year.
The success of the wealth management products has steered many households away from bank deposits, leaving banks with less liquidity for lending. Most loans are now channelled through "shadow banking," which are fuelled by wealth management products to a large extent. Loans from trusts come with interest of 20 percent a year, a rate taken up only by companies with their backs to the wall. It is not a rate a car dealership, for example, could afford for long.
We see the liquidity squeeze in June as a sign that the new government really intends to change the structure of the economy.
The squeeze sent a message to banks to reduce their exposure to wealth management products, entrusted loans and bankers' acceptances and return to lending under the stronger, regulated part of the financial system. We expect that the reserve ratio for banks will be decreased and wealth management activities will be required to appear on banks' balance sheets.
Moral hazard
However, this strategy will work only if households are informed that wealth management products don't have an implicit guarantee by the central bank. The bailout of the failed product sold by the Huaxia Bank in December 2012 has created a moral hazard.
Wealth management products currently have an average annualized return of more than 5 percent, compared to savings deposits that yield only 3 percent. Some products have an annualized return of 9 percent. We explain part of the strong demand for cars by these profits because most Chinese households are target savers.
Another portion of returns went into demand for housing, which has seen rising prices again after being depressed from July 2011 to late 2012. Once wealth management products become less prevalent and deposits become the norm again, the demand for cars will decrease, especially if consumer inflation rises above 3 percent.
The effect of lower demand and better credit terms for dealers won't likely be felt until the last quarter of 2013.
Economic restructuring would generally lead to lower car demand in the short term. That could lead to the exit of certain Chinese original equipment manufacturers and other "zombie" companies mainly kept alive by subsidies from their local governments.
Real estate could take a hit, along with about 30 related industries. Overcapacity in those industries would be eliminated. There would probably be some quantitative easing in the form of lower reserve ratios, but flooding the market with too much money could lead to inflation in 2014.
Local governments would have to tighten their belts and could afford only lower levels of new infrastructure, which would lead to even more pressure on the construction industry. The restructuring of the economy could take years. If policymakers follow the current plan, the economy would be much more stable and demand for cars would sustainably grow for decades to come.
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