Quotes of the Day
Old Chinese bomb factories never die. They just become car plants. At least that's what has happened at Qin Chuan in the northern city of Xi'an. The aging state-owned enterprise, which a decade ago made 130-mm artillery shells, now houses assembly lines that stamp out a boxy, four-door hatchback with a .8 liter engine, called the Flyer. Last year it built just 17,000 of the underpowered, Chinese-designed vehicles. Many went to taxi companies that were encouraged by provincial officials to buy them, but that doesn't dismay factory officials. China's car market is booming. In February, a Shenzhen-based maker of lithium batteries bought the Flyer factory. Although the new owner, called BYD (acronym for Brings You Dollars), has no experience building cars, it still plans to invest a war chest raised on the Hong Kong stock exchange to build a new facility that will start producing a family of Flyers as early as next year. "Once we're established," says Liu Zhenyu, the factory's general manager, "we'll use our batteries to make electric cars."
BYD's business plan might sound more credible if so many other companies did not have similar aspirations. There's no question that demand for cars is zooming. Purchases of passenger cars in China surged last year and rose 69% through the first nine months of this year, making China the fourth largest car market in the world behind Germany and signaling that the mainland's consumer culture is finally reaching critical mass. But the country already has more than 200 carmakers, ranging from creaky Communist-era holdovers to former washing-machine manufacturers to modern joint ventures run by Volkswagen, General Motors (GM), Ford and Honda—and almost all of them have responded to growing demand with massive capacity expansion programs. The accounting firm KPMG predicts that within two years China will be capable of building 4.9 million sedans a year—that's roughly equal to the output of Germany, and will outstrip even the mainland's fast-growing appetite for personal transport by 2.3 million cars a year.
Tao might appear to some as a killjoy. After all, China at the moment is the star on the world economic stage; the country's soaring need for a host of goods, including agricultural products and commodities such as oil, iron ore and aluminum, is a major contributor to global economic recovery. China is poised this year to pass Japan as the world's third largest importer, and its economy has become potent enough to threaten even the mighty U.S.—the mainland's surging exports to America put China on track for a massive $130 billion trade imbalance that has prompted members of Congress to call for punitive tariffs. Fears that China is taking U.S. manufacturing jobs has become a front-burner political issue.
Those closest to the gears of the global economy were among the first to notice China's growing prominence. Last winter, a broker in London named Albert Stahl watched the spot-market price for cargo-vessel leases rise to $22,000 a day for a ship big enough to transport iron ore. He assumed the spike was due to the impending Iraq war. But through the summer the price kept increasing; shipowners stopped giving quotes in expectation of prices jumping again the following day. Then Stahl began hearing reports of vessels the size of three soccer fields anchored off the Chinese coast for up to two weeks waiting for a berth—sometimes paying $100,000 a day for the privilege. Finally, he pieced it together. "There's a shortage of available ships in the world because of congestion in China, and nobody knows how to deal with it," says Stahl, a director at CTI Transport and Logistics. "Maybe someone will build more ships."
Considering the acres of empty cargo containers that piled up in ports around the globe during the SARS crisis, too few ships would appear to be a positive development for world trade. But concerns are growing that the situation is temporary—that China's economy is overheating, and the consequences of a busted bubble a few years hence are worrisome. Chinese state-run banks, already technically insolvent, have in the past year shot out new loans—for factories, roads and real estate—like a confetti cannon. According to China's central bank numbers, lenders in the first half of this year handed out about $230 billion, double the amount loaned during the same period last year, resulting in an astonishing 23% increase in total debt. It's just not possible that China's banks have suddenly found so many new creditworthy ventures, says Nicholas Lardy of the Washington, D.C.-based Institute for International Economics. "We've seen the greatest credit expansion in the past 25 years," he says. "I'd expect companies that borrowed heavily to face difficulties when the next downturn starts."
Easy credit has made it simpler for Chinese firms to pile into the car industry. A few years ago, as mainlanders began amassing enough disposable income to buy TVs, appliances and consumer electronics, companies crowded into those fields, driving down prices and profit margins until now only a handful of the largest are able to compete. Today, the hot zone is autos, where sales are accelerating and margins can be fat. "It's too hard to make money from washing machines now," complains Zhao Yong, a director of Guangdong-based Midea, an appliance maker that plans to buy a bus factory near the China-Burma border. "So we'll start making buses and move into sedans." Others have devised similar strategies. Sanxing Aux, producer of China's cheapest air-conditioners, last month announced it had purchased a carmaker in Manchuria and will soon unveil a line of sport-utility vehicles. At least three other electronic-goods makers have announced intentions to buy auto plants. And China's leading liquor maker, Wu Liang Ye, has perhaps anticipated marketing synergies between drinking and driving by revealing plans to get into the car business.
These would-be General Motors will have to compete with General Motors—and Ford, Toyota, Honda, Volkswagen and other more experienced multinationals that are muscling for market share. GM, which has been making Buicks in China since 1999, will soon launch Cadillacs and plans to increase total production by 50% in the next two years. In a first for the country, the government last week announced it will allow GM to export directly to the mainland without going through a Chinese partner. Ford last month said it plans to increase production sevenfold to 150,000 cars a year. Volkswagen, maker of the best-selling autos in China, plans to invest nearly $7 billion to double capacity to 1.6 million cars over the next five years. "Many of the world's major auto makers have announced their market share targets in China, but not all of them will be able to achieve their targets," said Volkswagen CEO Bernd Pischetsrieder to the China Daily.
If the likes of Toyota and GM face an uphill struggle, the only real hope for domestic carmakers without joint-venture partners is to capture the bottom end of the market, then begin the slow ascent up the price-and-sophistication ladder. That's the path chosen by BYD, the former bombmaker. According to Automotive Resources Asia, sales of BYD's car, the Flyer, grew 29% in the first nine months of the year, outselling the Ford Fiesta over the same period. The Flyer retails for about $4,000, making it affordable to the 50 million Chinese earning at least $7,000 a year each, which the government considers middle-class. "Look around my office," says Liu, BYD manager. He's got one dusty filing cabinet, bare whitewashed walls and a view overlooking the decrepit former bomb factory. "We can get by on the slimmest profits."
The Flyer was designed by BYD Chinese engineers, but at least two other companies are suspected of trying to cut costs through a time-tested Asian shortcut: copying Western designs. Analysts once considered cars too sophisticated to knock off. Then a small company in Anhui province called Chery began making a Volkswagen-like subcompact with components provided by suppliers that were believed to have signed exclusive deals with Volkswagen's joint venture. More recently, Chery has run afoul of GM by releasing a car, called the QQ, that looks almost exactly like a GM model called the Spark that hasn't even hit the market in China yet. Today, PSA Peugeot Citroen, the French maker of the successful Citroen sedan in central China, faces a similar problem. A local producer called Shanghai Maple recently introduced a model that looks startlingly like the Citroen—same body, same interior, even the same way of tooting the horn from the turn-signal toggle. "It's exactly the same as the Citroen except half the price," boasts Liu Xiaojun, a Shanghai Maple dealer in Beijing. Citroen suspects that Shanghai Maple poached its suppliers, and "we are considering legal action," says Jean-Claude Germain, chief representative of PSA Peugeot Citroen in China.
Even in this hyper-competitive environment, several years may pass before supply outstrips demand, but the effects are already being felt. The cost of a sedan dropped 7% this year in China. The auto sector isn't the only mainland industry risking overcapacity. China's soaring demand for metals has caused a sharp increase in raw-materials prices this year. But the country is splurging on factories to process feedstock into girders, car parts and other components; overinvestment could eventually cause prices to collapse. A metals trader in the U.S., for example, hangs a world map on his wall with black dots indicating the location of aluminum plants. Most producing countries have five or six dots; China has 130. Many of the mainland plants are expanding capacity, and another 47 are under construction or being planned. "China is building smelters like McDonald's opens restaurants," says the trader, who asked not to be identified. He's worried, because China used to be a net importer of aluminum. Last year it exported 200,000 tons of it, and far more could hit the market in coming years.
The same scenario of too much, too soon applies to a range of commodities. Walk through one of China's biggest steel producers, Anyang Iron & Steel. As cauldrons the size of railroad cars carry red-hot slag to rolling machines, the company's vice chairman, Wu Changxun, points outside the factory to a dirt expanse as big as several football fields. Workers are erecting a new foundry that will more than double the plant's output. It's part of the 50 million tons in increased capacity expected nationwide by 2005—enough to equal China's surging imports. "Banks are offering us loans even without our asking," says Wu. That money will have to be repaid—letting extra capacity sit idle is no option. China's demand for steel is so strong that imports have doubled over the past two years, but if the economy cools down and demand drops, "there's a distinct possibility [Chinese steelmakers] will spew out steel and crash the world market," says Cameron Hunt, senior steel analyst at the London-based Metal Bulletin Research.
The central government's economic-planning body, the State Development and Reform Commission, has for several months pondered ways to rein in expansion of what it calls "overheated industrial sectors," including auto, aluminum and steel. So far, it hasn't announced any changes. The central bank earlier this year ordered lenders to boost their deposit reserves by 1 percentage point to 7%. That was supposed to reduce the money supply and slow down lending, but it appears to have had little effect. The government seems unable to decide if the country's expansion pace is just right—after all, China must generate 12 million-15 million new jobs annually just to keep pace with its population growth—or if dangerous bubbles are forming. In June, for example, the central bank tried to end overbuilding in real estate by curtailing mortgages for homes not yet constructed. Two months later, the State Council issued a contradictory policy statement that not only encouraged mortgage lending but also "enhanced loan support" for developers.
As long as the lending taps remain open, developers will keep building. Last year mainland China produced enough new floor space to cover an area the size of Hong Kong—1.2 billion sq m—and new investment this year will rise 25%. Property sales growth, however, has declined by 20% this year. Developers don't seem worried. Vantone, a leading Beijing-based builder, last month put 450 apartments on the market at $200,000 each. Within six hours, it had taken in cash deposits for a quarter of them, and Vantone chairman Feng Lun says he expects the rest to sell within three weeks. Nearly all his buyers took out mortgages even though the developer has yet to finish laying the foundations. Feng chuckles at the idea that banks would try to cool the market by restricting loans. They'll keep lending, he says, because "banks have their own interests in mind."
But banks have grown dangerously exposed to the property market. Beijing alone has more than 3,000 developers, all highly leveraged. Property prices have remained essentially flat across the mainland, with the exceptions of Shanghai and Beijing. At the same time, unsold properties have increased fourfold over the past four years, tallying 230 million sq m last year. Though real estate demand should remain strong—an estimated 10 million Chinese move to the cities every year—for now, supply is simply growing too fast. "The laws of property cycles have not been repealed for China," says Peter Churchouse, who follows property trends in China for Morgan Stanley. "Eventually, the construction companies and the banks that backed them are going to get creamed."
No one knows whether the same scenario will be repeated in other hot sectors, or what the damage might be. China's economy isn't close to collapse. The country will remain the world's premier export power, with the value of what it sells abroad equal to roughly 30% of its total economy (the figure for the U.S., in contrast, is 10-12%). Exports provide China with a major source of income to ride out a contraction at home. China's banks are so flush with the savings of ordinary Chinese that a meltdown is unlikely.
The danger, however, is that the government will let the pressure build until the economy is so saturated with excess goods that banks must cut off credit abruptly, pushing the economy into recession. Economies always look and feel great when credit is easy and factories are coming on-line and new developments are in the works. But at some point, all those washing machines, apartments and automobiles have to be converted back into currency. The question hovering over China's economy now: Are there really enough buyers out there?
- Matthew Forney | Xi'an
- China is making more cars, TVs and washing machines than it can consume. Eventually, this glut could swamp the world