China: Cars, SARS, and a booming economy - but for how long?
By Megumi K. Sunako
28 May, 2003
Source: J.D. Power-LMC
Megumi K. Sunako, Senior Analyst, J.D. Powerand Associates
Somewhat surprisingly, preliminary reports indicate that China’s booming automotive market received an unexpected boost from SARS in April, as consumers rushed to buy cars to avoid using public transport and the SARS virus. With a number of new model launches and price cuts, conditions for vehicle purchasing in China have never been more favourable. However, if the epidemic is not contained quickly, damage could spread more widely to the economy and undermine the automotive market. Much depends on whether SARS will constrain China’s economic growth potential and stunt the emergence of private sector demand for new vehicles.
SARS threatens China’s explosive economic growth
China’s economy, which has expanded at explosive rates over the past year, is now facing a significant challenge due to the recent outbreak of Severe Acute Respiratory Syndrome (SARS). The government’s admission that the SARS epidemic has been spreading more rapidly than previously reported and subsequent authoritarian measures taken to contain the epidemic have led to a near-panic situation in Beijing and a rise in social tensions in SARS-affected areas. For global investors, the outbreak of SARS has been a painful reminder that even China, which led the world’s economic growth last year and has been one of the most preferred investment destinations, is vulnerable to unexpected domestic crises that can threaten its economic growth. Worse, the government’s initial failure in handling the epidemic has raised a serious concern once again over the credibility of any government report. Latest developments suggest that the spread of SARS might have reached its peak, but unless the epidemic is quickly contained, the damage to the economy could spread from a limited impact on tourism and retail sales to the rest of the economy – especially foreign direct investment (FDI) and export-oriented manufacturing operations, China’s main engines of growth. The Communist government’s top officials are also acutely aware that their political legitimacy rests on their ability to deliver economic growth. A possible economic slowdown will fuel a surge in already high unemployment and social discontent. That could undermine support for the ruling Communist party, as well as China’s reputation as an emerging global industrial powerhouse.
Despite the recent turmoil caused by SARS, China’s economic performance in the first four months of the year remained robust, and the impact of the epidemic on the economy has been largely limited to tourism and retail sales. The country’s year-over-year GDP growth in the first quarter was a stunning 9.9 percent – the highest rate since 1996 and far exceeding analysts’ expectations. Moreover, the government’s special release of a GDP growth rate for April alone indicates that the economy continued to grow by an impressive rate of 8.9 percent even amidst the spread of the epidemic. While the accuracy of official data is debatable, there is little doubt that the economy’s major growth engines kept pace through April. Led by export-oriented manufacturing operations, especially by strong output of vehicles, mobile phones and computers, industrial production was up 15 percent in April, compared to an average of 17 percent in the first quarter from year-ago levels. Both exports and imports maintained year-over-year growth rates of over 30 percent every month from January through April. Reflecting continuing heavy government spending on infrastructure, fixed investment has also remained robust. Even the massive inflow of FDI so far has not been disrupted.
Among limited data released for April, the only notable change was growth in retail sales, which weakened from an average of 9.2 percent in the first quarter to 7.7 percent in April on a year-over-year basis. Understandably, consumers avoided unnecessary shopping because of SARS. Apart from impacts on retail, hotels, and airline industries, no major disruption in manufacturing, supply chains, and export operations has been reported.
How large is SARS’ impact?
While it is too early to determine the magnitude of SARS’ impact on the economy, the threat posed by the epidemic should not be underestimated. One good thing is that China’s reliance on the service sector, which has been hit hard by SARS, is relatively small. Unlike Hong Kong and Singapore’s service-intensive economies, China’s service sector accounts for only 34 percent of GDP (compared to 70 percent in Singapore), and its foreign and domestic tourism represent less than two percent and four percent of GDP, respectively.
Nonetheless, there are risks that the country’s large manufacturing sector, which accounts for about 50 percent of GDP, will also be affected, unless the epidemic is quickly contained. Manufacturers, who need face-to-face contacts to take new orders, are already experiencing declines in orders. One example is the textile industry, where foreign buyers are shifting their orders from China to other countries, such as India and Pakistan.
Another major concern is that FDI inflows could be delayed, if not cancelled, because major government offices in Beijing have SARS victims and are unable to finalise agreements. A possible slowdown in FDI inflows could have an impact on the booming export-oriented manufacturing operations and thus overall economic growth. In addition, a setback in consumer spending would be another blow to an economy that needs private consumption growth in order to reduce the government’s deficit spending.
It should be remembered, however, that the SARS epidemic has not changed the economy’s fundamental structural problems, although SARS may make it difficult for the government to address them. For example, the nation’s banking-sector reform has made little progress in clearing out mounting non-performing loans, continuing to present a risk of a financial crisis. A recent collapse of a take-over deal of a Chinese bank by Newbridge Capital (a US investment firm) symbolised the difficulty allowing foreign management into the troubled Chinese banking sector. Privatisation of inefficient state-owned enterprises (SOEs) is progressing slowly. When restructuring of SOEs takes place, it often creates millions of dislocated workers. Luckily, China’s new leadership has finally agreed to co-operate with the WHO in order to restore its credibility in handling the crisis and to regain investor confidence. Optimism is rising that the country will soon overcome this crisis.
Economic outlook is still on track
Stronger-than-expected economic growth in the first four months of this year may warrant a substantial increase in China’s GDP this year, but analysts have remained cautious about raising their forecasts due to SARS. Most analysts expect that SARS’ direct and indirect damage to the economy could reduce China’s annual GDP by 0.5 to 1.0 percent. GDP growth forecasts for 2003 fall into a wide range between 6.5 percent and 8.5 percent, illustrating uncertainties surrounding the course and impact of SARS. In the second quarter, a further weakening of consumer spending is expected, as the government shortened a normally week-long May Day holiday – a major travelling and shopping season – to just a few days. Some delay in FDI inflows also appears to be inevitable due to travel warnings, and wary investors may attempt to reduce their risks by widening investment destinations beyond China. At least at this point, the higher end of the GDP growth forecast (8.5 percent) appears to be most plausible. The lower end of the forecast (6.5 percent) assumes a sharp economic slowdown over the remainder of 2003, which seems unlikely, given the fact that no major disruption has been reported in export and manufacturing operations.
The nation’s newly installed leadership is committed to curbing the risk of economic slowdown by continuing expansionary fiscal and monetary policies – a reminder that the nation’s economic growth, and thus political stability, is Beijing’s foremost priority. Following emergency funds to fight against SARS, the government announced a tax relief package for businesses which are hit hard by the epidemic. That, however, only adds to strains on public finances. Indeed, SARS has hit the economy at a time when consumer spending growth is finally gaining momentum and is expected to become a main driver of overall economic growth in the future. Over the past several years, China’s economic growth has been bolstered by massive government deficit spending, in order to offset weakness in consumer spending. The shift to more reliance on consumer spending– meaning more sustainable growth – may be delayed. Moreover, a further weakening of consumer spending might bring back a deflationary trend, which has finally appeared to subside in recent months.
Successful economic reform - the key to future growth
With the SARS epidemic peaking, the focus of China’s long-term economic outlook may soon return to its fundamental structural issues. Progress in reform programmes such as privatising SOEs and allowing foreign competition will continue to be decisive forces to sustain China’s high economic growth. A positive development is that the current SARS crisis has forced the government to add a degree of transparency in public policy management– a critical factor for attracting future foreign investment.
Another fallout of the crisis is that the epidemic has inevitably turned the government’s attention to the weakness of its medical systems, especially in the nation’s impoverished rural areas. While narrowing income disparity between affluent coastal urban areas and poor rural areas has already been one of the government’s top economic priorities, SARS may accelerate the efforts and help bring economic growth, and thus political stability, to rural areas where two thirds of the population reside. Barring yet another outbreak of SARS or a similar crisis, China’s economy is expected to post annual growth of seven to eight percent or even higher over the next five years.
Auto sales may benefit from SARS
Despite (or perhaps because of) the outbreak of SARS, China’s automotive market has continued its robust growth, providing a major impetus to the country’s industrial output and consumer spending. In the first quarter of 2003, passenger car sales were up 100 percent from year-ago levels, albeit based on relatively low sales in the first quarter of last year. Total light vehicle sales, including light commercial vehicles, are estimated to have increased by over 50 percent during the same period. While detailed data are yet to come, preliminary reports indicate that major cities in China witnessed a substantial surge in passenger car sales in April after the government admitted the spread of SARS. In Beijing, one of the most severely SARS-infected cities, passenger car sales reportedly jumped by over 20 percent from a year ago, as people tried not to use public transport to avoid catching the SARS virus. That means that when consumer spending in the overall economy was weakening in April, car sales were rising.
Over the remainder of the year, however, maintaining 50-100 percent year-over-year growth is expected to be difficult, as sales were high in the second half of last year. Most likely, sales growth will slow in the latter half of 2003. Although consumers rushed to buy cars amidst the spread of SARS, consumer confidence in future income and economic growth has been weakening, which could slow down vehicle sales. Thus, China’s light vehicle sales are expected to grow by about 20 percent this year to nearly 3.4m units, compared to 2.8m units in 2002, with passenger car sales reaching 1.5m units.
While a surge in vehicle sales amidst the SARS epidemic (at least so far) was unexpected, favourable growth factors for China’s automotive market have remained unchanged. This year alone, the introduction of a total of 40 to 50 new and attractive models are expected, mostly from foreign joint ventures in China (and about half of them have already been launched). Due to intense competition, prices of cars have kept falling and are expected to decline by abouteight percent this year, following aseven to eightpercent decline last year.
Inaddition, the government is committed to making vehicles more affordable, by reducing fees and taxes. The planned introduction of foreign automotive finance companies, which has been delayed since China’s WTO entry, should boost car sales among individual buyers. At present, about 90 percent of car purchases are done by cash, as China’s local consumer financing companies have yet to provide sufficient and sophisticated lending services. With all these favourable conditions for the future, China’s automotive market is expected to continue its robust growth. Thus, J.D.Power and Associates’ forecasts for the next five years remain unchanged fromthe last assessment, with passenger cars sales reaching 2.9m units and total light vehicle sales exceeding 5.5m units by 2008.