On the starting grid

Predictions that WTO entry would lead to the demise of the domestic
auto industry have proved wide of the mark. Instead, foreign carmakers,
particularly Japanese, are eyeing China as a low-cost production base.

Predictions that WTO membership would lead to the sudden collapse of
China's auto industry seem to have proven false, at least for the
moment. Import tariffs on passenger cars were cut from 70-80 per cent
to 43.8-50.7 per cent at the start of this year. However, the initial
increase in foreign car sales has been modest, in part because of the
low base of comparison. China imported 23,500 passenger cars in the
first five months of this year, comprising less than 6 per cent of all
domestic sales, according to figures from the China Association of
Automobile Manufacturers.

Nevertheless, WTO membership is already forcing rapid changes in the
domestic auto sector and company comments at this year's Beijing
International Auto Show, held in June 2002, suggest that the
restructuring process will accelerate as state-owned carmakers are
streamlined and Japanese producers move aggressively into the China
market. US and European carmakers, for the moment, are showing greater
caution, after heavy capital investment by General Motors in the
mid-1990s raised questions about the sector's long-term profitability.
Falling prices and margins already seem to be generating
rationalisation. The recent merger of Tianjin Automobile Industry Group
with Changchun First Auto Works, China's largest carmaker, shows signs
of having been forced on FAW by industry regulators. The merger will
lead to enormous redundancies at Tianjin Auto: 45,000 employees, or
three-quarters of the workforce, are set to lose their jobs.

As in agriculture, it appears that prices in the automotive sector are
adjusting to international levels, even though the actual volume of
imports remains tiny – and smaller producers like Tianjin Auto are
going to the wall. The only local producers that have not slashed
prices significantly are Volkswagen's two joint ventures with FAW and
Shanghai Automotive Industry Corporation (SAIC), which suggests that
these companies' dominance of the local market (they hold a combined
market share of over 50 per cent) could be maintained as weaker
producers are forced out.

Given the overcapacity in the sector, foreign carmarkers are moving
more cautiously than they did a decade ago. GM, whose massive Buick
joint venture with SAIC was China's largest single foreign investment
at the time of its launch in 1995, made an early effort to win market
share by investing in local production.

GM changes its plans

In light of the recent tariff reductions, however, this strategy shows
signs of backfiring, as sales growth has failed until recently to keep
pace with projections. Unlike many non-US carmakers, GM no longer
intends to make large new investments in China: the company announced
in April that its plan was to improve utilisation at its existing
production lines.

The one new investment originally planned by GM China this year was a
purchase of equity in Liuzhou Wuling Motors, a medium-sized carmaker in
southwestern China. This plan was later abandoned when Wuling's
dollar-denominated B shares rose in price when the share market was
opened to Chinese investors. GM and SAIC are now planning to limit
their co-operation with Wuling to a contractual joint venture.

Likewise, Germany's BMW has been unusually slow to enter into domestic
production, although its imported vehicles have been gaining a rising
share of the luxury market. Plans for a 50-50 joint venture with
Brilliance China Automotive Holdings, which had been expected to go
through in the first half of 2001, was finally given official approval
last month. The delay was partly due to alleged accounting problems
that have led to the investigation of Brilliance's former chairman,
Yang Rong. However, another cause may be the dramatically weaker
operating performance at Brilliance itself which, like many Chinese
carmakers, has been hard hit by falling prices as consumers postpone
their purchases. Brilliance announced a loss for the first half of the
year, and even these figures may be revised downwards.

By contrast, Japanese automakers appear to have been cautious but
shrewd in acquiring production assets in China. All the major producers
are taking tentative steps into the market. Nissan is in preliminary
talks with Dongfeng Motor on the possible production of trucks and
small cars for export. Toyota, has begun providing technical assistance
to First Auto Works, and will soon begin producing cars in Tianjin in
collaboration with the newly merged FAW operation in the city. Hainan
Mazda, a joint venture between FAW and Mazda Motor Corp, launched the
Familia sedan last month.

The most ambitious expansion plans, however, are those of Honda, which
has acquired the troubled Dongfeng joint venture in Guangzhou from
Peugeot-Citroen of France. In early July, Honda announced plans for a
new plant in the city to produce subcompact cars for export to Europe
and Asia. If fully utilised, the plant's annual production capacity of
300,000 units would make China a net vehicle exporter on current trade
patterns. This would be a surprising reversal of the outcome expected
when Beijing joined the WTO, but one that China's low labour costs may
make increasingly attractive.