China's automobile market in 2001 turned in its best performance since 1994. The country churned out a total of 2.33 million non-farm motor vehicles, up 12.8 percent over 2000 (see Table 1). Automakers sold 2.36 million vehicles, some of which came from stockpiles, a year-on-year increase of 13.2 percent. Actual production and sales are probably even higher because these statistics, provided by the China Association of Automotive Manufacturers, came only from the 102 manufacturers licensed by the central government. In 2001, China produced 742,373 passenger cars and sold 756,609, up an impressive 20.4 and 21.1 percent, respectively, over 2000 levels.

The double-digit growth in auto production and sales last year was, in part, a result of what local analysts call the "fourth wave of investment" in China's auto sector. Negotiations between multinational companies and Chinese automakers have been intensifying since mid-2001. CEOs of leading multinationals have visited China one after another, meeting government leaders, negotiating with potential Chinese partners, and clinching new deals. BMW AG obtained government consent for a joint venture project with Brilliance China Automotive Holdings Ltd., while Hyundai Motor Co. teamed up with Dongfeng Motor Corp. through its subsidiary, Dongfeng-Yueda-Kia Motors Co. Ltd. Renault-Nissan Suisse SA started negotiations with Dongfeng on expanding cooperation in car assembly, and Daimler Chrysler AG has been talking with First Automobile Works Group Corp. (FAW) about truck manufacturing and with Dongnan (Fujian) Automobile Industry Co. about launching the Mitsubishi Lancer. In April, Hyundai signed a 30-year joint venture agreement to begin assembling cars later this year. And Volvo Truck Corp. is discussing a joint venture with China National Heavy Duty Truck Group in Jinan, Shandong.

Foreign automakers have also decided to commit additional funds to their existing investments (see Table 2). Volkswagen AG will add 14.1 billion RMB ($1.7 billion) and PSA Peugeot Citroen will pump 630 million RMB ($76.1 million) into their China joint ventures. Volkswagen recently signed an agreement to extend its joint venture agreement with Shanghai Automotive Industry (Group) Corp. (SAIC) for another 20 years and increased Shanghai Volkswagen Automotive Co. Ltd.'s registered capital from 4.6 billion RMB ($555.8 million) to 6.3 billion RMB ($761.2 million). DaimlerChrysler recently extended its joint venture, Beijing Jeep Corp., for another 30 years. General Motors Corp. (GM) has successfully set up its third joint venture through a partnership with SAIC and Liuzhou Wuling Automotive Co. Ltd., a mini-vehicle manufacturer in Guangxi. Ford Motor Co. is gearing up to introduce a series of car models once Chang,an Ford Automobile Co., Ltd. in Chongqing launches the Fiesta/Ikon later this year.

Thanks to China's World Trade Organization (WTO) terms of accession, the new wave of investment in the country's automotive sector will cover a wide spectrum of auto products, from passenger

China's WTO Commitments Relating to Auto Investment According to the WTO Report of the Working Party on the Accession of China, with regard to foreign investment in the motor vehicle sector, China agreed to: Amend the 1994 Automotive Industry Policy to ensure compatibility with WTO rules and principles and to phase out the following two subsidy measures: loan and foreign currency priorities based on export performance, and preferential tariff rates based on percentage of local content. Eliminate, two years after accession, all measures applicable to motor vehicle producers that restrict the categories, types, or models of vehicle they can produce. Allow provincial governments to approve foreign investments in motor vehicle manufacturing of up to $60 million one year after accession, $90 million after two years, and $150 million after four years--up from the present $30 million cap. Remove the 50 percent foreign equity investment limit for engine manufacturing joint ventures. Unify laws and regulations with regard to both domestic and imported motor vehicles and auto parts so that imported products enjoy the same treatment as similar domestic products. Wayne W. J. Xing

cars and heavy-duty vehicles to farm trucks and motorcycles. Multinational auto manufacturers will introduce platforms instead of individual vehicle models. More important, new areas of investment will open up in sales, distribution, and after-sales services, including auto financing and insurance. Auto companies are already branching out into new markets in China: Ford's Hertz rental car division opened offices in Beijing, Guangzhou, and Shanghai in April. Volkswagen Finance, General Motors Acceptance Corp., and Ford Motor Credit Co. have all set up offices in China and are waiting for new regulations to guide the licensing process.

Meanwhile, foreign investors are beginning to see medium-sized and small domestic companies as attractive partners because they are less bureaucratic and less burdened by over-staffing and debt.

Global automakers have some reason for optimism about the effect of China's WTO entry on their business in China. China has committed, in its WTO protocol of accession, to reduce tariffs on cars, buses, and trucks gradually over the next few years--by more than half in many cases (see Table 3). China will cut tariffs on more than 160 auto parts and components from an average of 25 percent in 2001 to 10 percent by July 1, 2006.

China also committed to increase its import quotas on motor vehicle products by 15 percent annually, based on quota values in 2000, and eliminate import quotas entirely on January 1, 2005 (see Table 4). For motor vehicles and parts, the quota value for 2002 will be close to $8 billion. China will also eliminate import licenses for engines in 2003; motorcycles, trucks, and buses in 2004; and passenger vehicles in 2005 (see Table 5).

Through this new round of investment, the Chinese auto market is becoming the front line of global competition for heavyweight international players. But multinationals will also face local players that are launching models, targeted at Chinese consumers, that are competitive in terms of both cost and versatility.

Through this new round of investment, the Chinese auto market is becoming the front line of global competition for heavyweight international players. But multinationals will also face local players that are launching models, targeted at Chinese consumers, that are competitive in terms of both cost and versatility.

China agreed, in the Report of the Working Party on the Accession of the PRC (Working Party Report), to comply with the WTO Agreement on Trade-Related Investment Measures (TRIMs) upon entry to the WTO. Under TRIMs, China cannot subsidize export performance or require that companies use locally produced parts and components, restrict the types of vehicles produced, or maintain separate regulations for domestic and imported products, among other requirements (see p.10).

Also of concern for auto manufacturers, China agreed to confer the right to trade on foreign individuals and enterprises, regardless of whether they are registered in China (see The CBR, January-February 2002, p.16).

China is also required to open certain services markets that will have a significant impact on the auto sector. These include distribution, financing, insurance, road transportation, storage and warehousing, maintenance and repair, and rental and leasing. WTO terms will generally permit wholly foreign-owned subsidiaries in these areas by 2005 (see below).

Despite the fact that China's auto industry has come a long way since the mid-1980s, when the government decided to invite multinationals to establish joint venture manufacturing facilities in China, officials still need to address major problems. Most domestic manufacturers are unsure what to expect or how to adjust to the gradual implementation of China's WTO concessions. China's drastic reduction of import tariffs at the beginning of this year and increase in import quotas for 2002 surprised government agencies and auto enterprises. For example, Tianjin Automotive Industrial (Group) Co., Ltd.'s sudden decision in early January to reduce the price of its cars by 20 percent in response to tariff cuts created a domino effect of price cuts by almost all players.

The government acknowledged in its recent 10th Five-Year Plan for the Development of the Automotive Industry (2001-05) that China's auto market is still highly fragmented. Though the passenger-car market in particular has changed from a sellers, to a buyers, market over the last decade, many of China's more than 100 original-equipment manufacturers (OEMs) lack economies of scale. Most Chinese OEMs have weak capabilities in new product development and invariably have their own parts supply systems. But these parts suppliers, which are barely able to meet their own economies of scale, charge higher prices than imports and are unable to develop new products to meet OEM demand. Except for a few early birds in the Chinese auto market, most auto enterprises are faced with poor or no returns on their investment.

These problems are the results of both macroeconomic and microeconomic deficiencies. Until recently, the central government controlled China's auto industry with an extensive and strict planning and project-approval system. Paradoxically, such tight central-government control failed to curb repetitive investments by different branches of the central and local governments for a simple reason: high tariffs protected the market from imports. Local governments, meanwhile, blocked vehicles made in other parts of China, making auto assembly highly profitable. Even worse, investment decisions were and still are often made by officials who are not responsible for project operations. Public funds therefore go to the construction of assembly facilities, leading not only to overcapacity but also to many unfinished and idle manufacturing operations. Interestingly, most joint ventures have also benefited from this government protection.

China's domestic manufacturers also suffer from poor management. General managers at state-owned enterprises are normally appointed by higher-level bureaucrats. These general managers thus tend to be more concerned with their political performance than the profitability of their enterprises. For joint ventures, the mandated 50-50 equity share split between foreign and Chinese partners has resulted in inefficient decisionmaking.

China has 1.3 billion people--and more than 300 million families--and is therefore the world's largest potential auto market. Currently the country's per capita GDP is low by international standards, and the majority of Chinese families are preoccupied by issues such as housing, medical care, and their child's education. Nevertheless, the absolute number of families that can afford to buy a car--anywhere from 3 to 5 million--though small in percentage terms, is large enough to sustain rapid growth in the auto market. If the consumer environment for cars improves significantly, through the reduction or elimination of excessive taxes and fees, operational restrictions, and red tape in vehicle purchases and registrations, such purchasing power may translate into high auto sales.

Faced with overcapacity and cutthroat competition, auto enterprises must adjust their product and organizational structures to improve efficiency if they are to meet rising market demand. China's WTO entry offers a good opportunity to reorganize the auto sector, and the government is expected to facilitate such a reorganization soon. For example, FAW, China's largest auto group, has reportedly signed a letter of intent to acquire Tianjin Automotive Industrial (Group), Toyota's partner in China.

In addition, the government's official, if gradual, withdrawal from direct enterprise management and control will help create room for an open market to develop under conditions of equal and fair competition. Regional and corporate protectionism, favoritism, and corrupt practices will, ideally, diminish. All of these new developments may offer the best chances for domestic OEMs and suppliers to reorganize their assets through mergers and acquisitions. The low cost of labor in China will help well-managed domestic enterprises and joint ventures to become successful vis-a-vis imports.

The biggest issue currently facing the Chinese auto sector is the future of equity control in auto assembly operations. China's WTO commitments do not include a timetable to eliminate equity controls in auto assembly facilities, and the Chinese government is expected to limit foreign equity ownership to no more than 50 percent for some time to come. Multinational automakers with joint venture facilities in China have expressed their readiness to buy out their Chinese partners and will increasingly pressure the government to lift the cap on foreign ownership.

By maintaining equity controls in vehicle joint ventures, China's decisionmakers aim to protect the national auto industry. Their definition of a national auto industry seems to include the following: 50 percent equity share ownership, a majority of parts and components supplied locally, independent new product development, and an equal say in management control. But such a definition goes against WTO principles and the trend of globalization in the auto industry. In essence, this is government-controlled competition and is by definition unfair (see p.14).

Given China's large population and market, rich resources, and abundant and competitive labor force, a fair and competitive national auto industry is surely possible. Multinationals readily point out that, even if they were to have 100 percent equity ownership of their PRC manufacturing facilities, they would be just as much a part of the Chinese auto industry as domestic firms. Even more important, China's market, if open to equal competition, will have ample room for some domestic automakers to emerge as global players--though it is still too early to tell which companies will prove successful.

The openness and global competition that WTO membership will bring are creating new companies and will likely force many existing companies out of the market entirely. The WTO's biggest impact on the auto sector may be the sudden realization, on the part of both the government and the industry, that it is in the industry's best long-term interest to shorten the phase-in periods to which China agreed in its WTO commitments, as protection will continue to undermine the strength of domestic enterprises (including joint ventures). Those that hope to survive the inevitable competition must act today as if it were already 2006, when tariffs will be 25 percent or less for motor vehicles and 10 percent for auto parts.

China's auto industry will not disappear because the country has joined the WTO. Indeed, two veteran Japanese auto executives who currently manage OEM joint ventures in China recently expressed their confidence in the emergence of a national Chinese auto industry. "I remember," said one of them, "that when we started to make cars in Japan, nobody believed that we could develop a Japanese auto industry."

Table 1 Production and Sales of Automobiles, 2001 (units) Production Percent Change Over 2000 Sales Percent Change Over 2000 Car* 742,373 20.39 756,609 21.10 Truck 802,353 5.02 818,433 5.62 Heavy 157,073 91.67 146,985 77.37 Medium 151,955 -1.17 162,747 -0.25 Light 362,823 -7.10 368,686 -7.12 Mini 130,502 -5.26 140,015 6.14 Bus 789,714 14.72 788,623 14.47 Large 11,496 44.55 11,431 47.63 Medium 48,169 34.03 47,906 33.45 Light** 246,625 4.42 246,623 4.66 Mini 483,424 18.39 482,663 17.82 Total 2,334,440 12.83 2,363,665 13.17 NOTES: * Including subcategory cars (cars classified as "light bus" such as the Geely Haoqing) ** Excluding subcategory cars SOURCES: China Association of Automotive Manufacturers, China Business Update (CBU)

Table 2 Major Car Assembly Projects in China, 2002
Company	Foreign Partner(s)	Products	Capacity (units)
FAW-Volkswagen Automotive Co., Ltd.	Volkswagen AG	Jetta, Bora, Audi	200,000
Dongfeng Motor Corp.	PSA Peugeot Citroen SpA	ZX/Fookang, Picasso	150,000
	Nissan Motor Co., Ltd.	Fengshen (Bluebird)	30,000
Shanghai Automotive Industry (Group) Corp. (SAIC)	Volkswagen	Santana, Passat, Polo	450,000
	General Motors Corp.	Buick Century, GL8, Sail	150,000
Tianjin Automotive Industrial (Group) Co., Ltd.	Daihatsu Motor Co., Ltd.	Charade, Charade 2000	150,000
	Toyota Motor Corp.	NBCV	30,000
Guangzhou Honda Automobile Co., Ltd.	Honda Motor Co., Ltd.	Accord, Odyssey	75,000
Chang,an Suzuki Automobile Co., Ltd.	Suzuki Motor Corp.	Alto, Swift	150,000
	Ford Motor Co.	Fiesta/Ikon	30,000
Geely Group	--	Haoqing, Merrie, Ulio	200,000
SAIC-Qirui Automobile Co., Ltd.	--	Chery	50,000
Guizhou Aviation Industry Group	(Subaru) Fuji Heavy Industries Ltd.	Skylark	50,000
Yuejin Auto Group Corp.	Fiat SpA	Palio	30,000
	--	Eagle/Unique	30,000
FAW Hainan Motor Co.	Mazda Motor Corp.	323/Premacy	50,000
Jiangsu Yueda Group Co., Ltd.	Hyundai/Kia Motors	Pride	30,000
Brilliance China Automotive Holdings Ltd.	--	Zhonghua	30,000
Shanghai JMStar Group	--	Meilu	30,000
Hafei Auto Manufacturing Co.	--	Baili, Saima	30,000
Jiangxi Changhe Suzuki Automobile Co., Ltd.	Suzuki Motor Corp.	Beidouxing (WagonR)	30,000
Xi,an Qinchuan Automotive Co. Ltd.	--	Flyer	30,000
Total			2,005,000
SOURCE: CBU

Table 3 Scheduled WTO-Mandated Tariffs for Cars, Buses, and Trucks (percent)
Cars Engine Size	2001 Jan.1	2002 Jan.1	2003 Jan.1	2004 Jan.1	2005 Jan.1	2006 Jan. 1	2006 July 1
Less than 3 liters	70	43.85	38.2	34.2	30.0	28	25
3 liters and up	80	50.70	43.0	37.6	30.3	28	25
Buses Number of seats
30 and up	45	37.5	33.3	29.2	25
20-29	60	47.5	40.0	32.5	25
10-19	65	47.5	40.0	32.5	25
10-19 (diesel)	65	38.4	32.9	27.5	25
Gasoline Trucks Gross vehicle weight (GVW)
8 tons and up	30	30.0	25.0	23.3	20
5-8 tons	40	30.0	25.0	23.0	20
Less than 5 tons	50	37.5	33.3	29.2	25
Diesel Trucks GVW
20 tons and up	30	21.0	18	15.0	15
14-20 tons	30	24.0	22	20.0	20
5-14 tons	40	30.0	25	23.3	20
Less than 5 tons	50	37.5	30	29.2	25
SOURCE: World Trade Organization Protocol on the Accession of the People's Republic of China (Protocol of Accession)

Table 4 Import Quotas on Motor Vehicle Products ($ million) Description 2000 2002 2003 2004 2005 Motor vehicles and parts 6,000 7,935 9,125 10,494 No quota Motorcycles and parts 286 376 432 497 No quota Cranes and chassis 88 116 133 153 No quota SOURCE: Protocol of Accession

Table 5 Timetable for Elimination of Import Licenses on Motor Vehicles and Engines Passenger vehicles 2005 Buses 2004 Trucks (diesel) 2004 Trucks (gasoline, under 5 tons) 2004 Motorcycles 2004 Engines 2003 SOURCE: Protocol of Accession

China Business Review, Volume 29, Number 4, July-August 2002

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Last Updated: 18-Jul-02