BANKING on mainland market potential, more import car manufacturers are rushing to set up production facilities in China, undaunted by a policy shift that could make their journey bumpy.

At the frontline are Renault, Infiniti, and Jaguar Land Rover, which unveiled blueprints for Chinese plants with considerable fanfare earlier this year.

Sales of imported Renault rose 65 percent last year, while Infiniti and Jaguar Land Rover each chalked up gains of about three-fifths. Still, the three auto companies were minority players in the world's largest auto market, each with less than 50,000 units sold.

"Localization is the road that will take their performance in China to the next level," said Zeng Zhilin, research director of LMC Automotive. "By bringing their factories to China, foreign car brands can shake off high tariffs to offer more competitive prices and satisfy the consumer needs better and faster."

Starting in 1985, several international giants, led by Volkswagen and General Motors, set up joint venture production lines in China, hoping to cash in on a market where incomes were rising and per-capita car ownership remained low by Western standards.

Those that took pole positions before China's car sales really exploded in the last decade now hold a lion's share of the market in their respective segments. With car sales growth slowing, will the Johnny-come-latelies find themselves stuck at the gate?

Policy shift

Earlier this year, the National Development and Reform Commission and the Ministry of Commerce removed vehicle manufacturing from the list of industries where foreign investment is "encouraged" and downgraded it to "allowed" status. The policy shift was aimed at bolstering China's domestic carmakers, but if it sent a chill through the ranks of foreign automakers hoping to carve a bigger mainland presence, they didn't bare their souls about it at the Beijing Auto Show last month.

At the event, Carlos Ghosn, CEO of the Renault-Nissan Alliance, confirmed that Infiniti, the luxury division of the Japanese automaker, will start its Chinese production lines in 2014, and has nailed down two models to be manufactured on the mainland.

Chen Guozhang, CEO of Renault in China, said the French automaker has signed a letter of preliminary intent with China's Dongfeng Automobile to form a manufacturing joint venture.

Ralf Speth, CEO of British premium carmaker Jaguar Land Rover, said his company is still waiting for the regulatory green light for a vehicle manufacturing project with Chinese partner Chery Automobile and will introduce its best products to the country once the deal is finalized.

Others attending the auto show were a bit more guarded. Takanobu Ito, president of Japan's Honda, said production of the Acura luxury brand will be localized in China "at an appropriate time," and Kenji Nakajima, senior deputy general manager of Toyota in China, didn't rule out suggestions that a Made-in-China Lexus might be considered some day if sales on the mainland reach 100,000 units each year.

The coyness may be partly attributable to the change in government policy, but some market observers said Chinese authorities may no longer officially "encourage" new foreign investment in the auto industry but that doesn't mean they will discourage it.

According to industry insiders, foreign carmakers will still get the thumbs up on projects that involve the development of cleaner-energy cars and on joint venture projects where a domestic carmaker stands to benefit from the research and development expertise of a foreign partner.

"These rules are like new hurdles for manufacturing localization, which is still possible but more costly," said Zeng of LMC Automotive.

It is not the first time that the Chinese government has raised the investment threshold for new entrants with foreign nameplates. Last year, local engine manufacturing was added to the car parts required to be made in China by new joint-venture vehicle projects.

How this will all play out against a backdrop of slowing mainland car sales is uncertain. In the first quarter, vehicle sales slumped 2 percent from a year earlier, a sharp contrast to the 9 percent growth in the same period of 2011.

Excess capacity

According to audit, tax and advisory firm KPMG, there are about 100 automakers in China, but the top 10 represent roughly two-thirds of all cars sold. It estimates there are more than 6 million units of excess manufacturing capacity in the Chinese market - which is twice the size of the entire German car market - and that figure is set to grow to 9 million units by 2016.

"Of course, worries were swirling around the policy shift that plans for foreign-invested vehicle projects will be shelved to rein in the expansion of production under such circumstances," said Ye Sheng, auto research director at market research company IPSOS. "But let's face it, all the talk about redressing 'overcapacity' hasn't seemed to make a dent in the construction of new vehicle plants all these years, and perhaps not this time either."

When Italian auto giant Fiat Group and the Chinese GAC Group planted the cornerstone for their first co-invested plant in Changsha, Hunan Province, in 2010, the risks of an overheated auto boom had already caught the eye of authorities.

Though their first production lines won't be ready for use until this June, the two partners are said to be mulling the expansion of annual capacity to back up the localization of Jeeps, the American brand owned by Chrysler, which in turn is owned 58.5 percent by Fiat.

Is this just a way to expand production without going through the uncertain red tape for a new joint venture permit?

Similarly, Renault can use the plants its ally Nissan co-owned with local partner Dongfeng to carry out its Made-in-China plans, said Zeng, who noted the government policy actually has a lot of wiggle room.

China still needs to rely on fixed-asset investment to drive its economic growth, and the auto market is far from saturated, Ye noted.

"In the long run, China's urbanization will continue to unleash demand in cities with low car penetration rates or with pent-up desire for vehicle upgrades," he added, saying the current market downturn is a cyclical phenomenon consistent with the economy.

Premium market

Besides, the overcapacity problem might not be as serious as some portray it. Andrew Thomson, co-head of automotive, KPMG China, said it is not an industry-wide issue and certainly doesn't apply to every vehicle segment.

China's premium car market - the target of Infiniti, Jaguar Land Rover, Acura, and Lexus - has consistently bucked the downward trend in car sales. In the first quarter, that segment delivered a 36.7 percent growth in sales, according to Morgan Stanley.

"We have seen the recent success, in terms of the growth rates, that luxury cars and sports utility vehicles have been able to post," said Thomson. "We see this as a natural maturing process for the consumer and the market, which is to be expected as levels of personal wealth increase."

All automakers geared up for localization have their sights set on SUVs, which reportedly account for more than 70 percent of China's import car sales. Among the over 24,000 cars sold by mass-market brand Renault last year in China, more than 80 percent were its SUV Koleos.

But they still need to revamp their manufacturing blueprints to cater to the Chinese market, which prefers extended wheelbases and luxurious interiors, Zeng said.

The road to true localization is a long one. Circumventing present policy pitfalls might just be the next step.