General Motors continues to provide a glowing assessment of its Chinese investments. In fact, Wall Street analysts recently raised their earnings forecasts for the company because of strong demand for GM cars in China.

But investors arenít giving the company much credit for those profits or for managementís rosy view of Chinaís long-term contribution to GMís earning" />

Issue: May 2004


Keller



Chinaís Bubbles

by Maryann Keller

General Motors continues to provide a glowing assessment of its Chinese investments. In fact, Wall Street analysts recently raised their earnings forecasts for the company because of strong demand for GM cars in China.

But investors arenít giving the company much credit for those profits or for managementís rosy view of Chinaís long-term contribution to GMís earnings.

The reasons are obvious and have nothing to do with Wall Streetís so-called obsession with quarterly profits. Their concerns revolve around the simple fact that China cannot sustain the current level of economic growth and that the eventual economic slowdown will crush vehicle demand and prices.

Few economists believe that China is going to be able to negotiate a soft landing from the explosion of bad debt now overtaking the country. So current Chinese vehicle demand will quickly collapse when interest rates climb (as they have to) at a time when automobile assembly capacity is exploding.

Simultaneously, the Chinese auto industry, and specifically foreign investment within Chinaís auto industry, is a bubble within a bubble. Each global auto company has behaved in predictable fashion toward this potentially huge market.

Each has rationalized investment in China on the basis that it canít afford not to be there, that demand and supply will be in balance or that their own market share will grow at the expense of the competition. Their collective behavior is creating two more bubbles.

Car prices are already falling and Volkswagen, an early advocate of Chinese investment, is reporting both a lower market share and falling profits, as more supply floods the market.

VW is the extreme case of excessive euphoria about China but every other car company will eventually be disappointed by China. Investors, to their credit, are not looking at the short-term contribution of China but rather the long-term implications of China becoming a global automotive powerhouse in its own right.

The Chinese government has been explicit in its desire to create an auto industry that will export $100 billion in vehicles and parts by 2010. Although some exports will be from joint venture auto assembly or parts plants, local Chinese companies are expected to be able to sell vehicles and parts on their own. The government will develop an indigenous industry with foreign capital and technology by steadfastly resisting foreign ownership above the 50 percent level in each joint venture.

China has taken a page out of the Japanese and Korean playbooks. Both countries benefited from early participation by foreign companies while not permitting such an economically important industry to be depended on the financial fortunes and strategies of overseas corporations.

Foreign auto companies will be forced to maintain dual dealer networks, one for vehicles produced locally and another for their imports, despite the vocal protests by foreigners.

Chinese rules will limit the amount of profits earned by foreign auto companies and increase the amount of money they will have to invest in dealer networks. Their designs, engineering and know-how are already being pirated by local Chinese companies, problems that promise to get worse with the surge of investment in auto parts production. Amazingly, foreign auto companies are funding the development of their next wave of competition.

Does anyone truly expect that China will fail in its effort to create an indigenous and competitive automotive industry? The global excess auto capacity is now estimated at 20 to 25 million units. That is one big bubble that is going to get much worse when China achieves its goal.

Maryann Keller is a veteran auto industry analyst and author of the books ďRude Awakening: The Rise, Fall and Struggle to Recover at General MotorsĒ and ďCollision: GM, Toyota and Volkswagen and the Race to Own the 21st Century.Ē

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