China’s auto sector depression soon to support growth

• China’s efforts to rebalance its economy towards a consumption-based growth model have seem to be going through increasing difficulties as retail sales continue to slow down. The key factor behind such slowdown is the auto sector, as it has been growing negatively since May 2018. Given that auto sales account for more than 28% of total sales, the decline drags down retail sales and, thereby, dampens China’s hope to keep relatively high growth from the rebalancing process.
• When looking into the reasons for such poor auto sales, the first thing that comes to mind is the economic slowdown since late 2017. Zooming into the differences in car sales and GDP growth across provinces, we can show the association of the car market with the broader deceleration of the macro-economy, but cannot fully explain why car sales in some provinces fall so dramatically notwithstanding their relatively resilient growth.
• One obvious factor that could be explaining the relatively low correlation between GDP growth and car sales is the regulatory environment. In fact, China’s environmental regulations have created tightened situations for auto market. Additionally, China’s tax rules have also escalated for small-engine cars, leading to a front-loading of purchases and a subsequent slump in the year-on-year growth rate of sales towards the end of 2018.
• A third explanation for the poor auto sales could be household debt, which is actually more dangerous for China’s rebalancing hopes. Although coming from a very low base, household debt has surged in the past few years. In 2018, the government’s push for deleverage reached households. The most leveraged ones had to face the consequence of much tighter access to credit, thus defying the purchase of consumer durables, most notably autos.
• Moving forward, the much easier credit condition is good news for the auto sector as well as the cyclical economic recovery. However, in the medium run, an eased financial environment will push for an increase in household debt, dampening the financial environment for auto market.
• Broadly speaking, increasing debt risk as well as more social considerations such as the environmental issues casts doubt on the sustainability of China’s consumption-led model down the road as there is still a long way before China to get there.

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