HONG KONG -- Larger-than-expected cuts to China's electric vehicle subsidies are set to hasten industry consolidation and help level the playing field for foreign competitors in the world's largest auto market.
So-called new-energy vehicles -- which include pure electrics and plug-in hybrids -- have been a bright spot in an otherwise gloomy market, which makes the subsidy reduction potentially devastating, particularly for smaller players.
Most China- and Hong Kong-listed auto companies reported disappointing figures during the recent earnings season, reflecting the industry's first annual sales decline in nearly three decades. Even Zhejiang Geely Holding Group, the country's top private automaker and owner of Volvo Cars, missed its sales target last year.
While NEVs accounted for only 4% of the auto market last year, sales grew 61.7%, compared with a 2.8% decline in the overall market.
Eco-friendly vehicles have until now enjoyed generous subsidies as part of Beijing's efforts to combat air pollution, and the reduction of those subsides by 50% to 60% this year caught many off guard. Analysts said the subsidy cuts, announced on March 26, were larger than expected and would further squeeze the profits of manufacturers and suppliers at a time when companies are struggling to raise retail prices amid weak consumption.
The government has also raised the minimum energy density and driving range for cars to be eligible for the subsides. For example, subsidies for pure electric vehicles with a range of 250 km to 300 km were reduced from 34,000 yuan (around $5,000) to 18,000 yuan. Authorities also ended subsidies for cars with a driving range below 250 km, and cut those for plug-in hybrids by 55% to 10,000 yuan.
"The subsidy cuts cast a great pressure to the entire auto industry," said Nick Lai, head of Asia auto research at JP Morgan. He said auto companies are likely to pass on part of the price burden to original equipment manufacturers and component makers as well as customers.
"The decline in subsidies will certainly accelerate consolidation in the industry," Lai added, saying he expects many smaller and obscure new-energy vehicle players to be forced out of business when direct government support ends. China currently has close to 500 companies in the NEV market, but few are profitable.
Despite a sluggish market, Lai believes consumers will have to bear some of the increased costs, as carmakers are likely to set higher prices when they launch new EV models this year.
Government subsidies and policy incentives have played a key role in the rapid development of electric vehicles in China. More than half of the world's electric vehicles were sold in China last year. As of 2018, China offered 111 EV models, compared with 32 in Europe and 11 in the U.S., according to Nomura. But critics say government support is often abused by obscure companies, many of which have little research ability and can only exist with subsides. The government has been gradually reducing direct subsidies since 2016 to let the market play a bigger role.
Currently, China's green car market is dominated by domestic players, including Shenzhen-based BYD and state-owned BAIC Group. But the drastic subsidy reduction could open the market up to more international companies.
Established automakers, including Volkswagen, Mercedes-Benz and BMW, have plans to roll out their first electric vehicles in the coming years.
"The subsidy cuts wouldn't deter but [will] likely hasten foreign brands' inroads given the diminishing subsidy difference," analysts at Morgan Stanley said in a research note on March 29. This is because local companies will have to make significant investments in their dedicated EV platforms to match the performance of global players' upcoming models.
While domestic electric vehicles generally compete on affordability, the high quality and reputation of global brands will attract middle-class customers, who are less price-sensitive, according to Toliver Ma, a Hong Kong-based analyst at Guotai Junan Securities. "The entrance of foreign car brands in the EV segment will definitely put more pressure on domestic players," he said.
As competition heats up, Ma believes that bigger automakers will come out on top, as they can bear losses longer thanks to revenue generated from their traditional car businesses.
Despite reduced subsidies and large financial burden, carmakers will have to continue investing in green technology to meet government requirements. Starting from 2019, automakers in China are required to dedicate at least 10% of their overall production to EVs or purchase equivalent credits from other makers. Under the cap and trade policy -- similar to those in the U.S. and Europe -- carmakers will be subject to sanctions if they fail to acquire enough credits.
"We continue to believe industry sales [will] continue its current momentum, as the government has a target to reach 2 million units of industry production and sales by 2020," Ma said.
Besides reduced subsidies, the fast-growing used-car market is also taking a toll on overall new-car sales.
"A large number of people, if they want to be mobile, have more choices now than new car purchases," said Bill Russo, founder and CEO of advisory company Automobility. Russo expects used cars will become a more popular option as the market matures.
"For a significant share of population, driving a five-year-old Maserati is probably just as good as buying a new Toyota or Ford," he said.
With more millennials and trustworthy third-party dealers entering the market, total transaction volume of used cars grew 11.5% to 13.8 million in 2018 -- nearly half the volume of new car sales, according to figures compiled by the China Automobile Dealer Association.
Millennials -- people born in the 1980s and 1990s -- accounted for 82% of used-car buyers, according to a survey published by China Academy of Transportation Science last year. Volkswagen, Toyota, Honda and Nissan are among their favorite brands.
Analysts say that branded used cars are more cost-effective options for buyers with limited purchasing power. The average price for used cars in China was 70,000 yuan, compared to 130,000 yuan for new cars, according to a report published by Credit Suisse in March. Policies to allow cross-regional used-car sales and the shifting preference of new-generation buyers will also boost the market, the report said.
But the used-car market is still largely untapped compared to more developed economies. In the U.S., about 2.4-times more used cars were sold than new cars. Consultancy iResearch expects used-car transactions in China to surpass current new car sales, hitting 29.6 million in 2022 as increased numbers of cars enter their replacement cycle.