World Automotive Outlook: Pressures Remain

Economist Intelligence Unit

Overview

The global car market expanded by 3.9% in 2004, the fastest rate for five years. Sales rose in the North American and western Europe markets, which collectively account for over 60% of global light vehicle demand. In addition, sales rose rapidly in the emerging world. Demand growth in China moderated from the pace seen early in the decade, but sales in India rose by 24% to over 1m units, making it the world's fastest-growing major market in 2004. The buoyant global demand experienced in 2004 will not be repeated in 2005. The Economist Intelligence Unit expects demand growth to weaken to just 1.2% in 2005 as the west European market stagnates and sales fall in both the US and Japan.

But demand should improve again from 2006 onwards and over the five-year forecast period as a whole world car demand is expected to increase by some 6m units (an average annual growth rate of 2.4%). Most of this growth will occur in the emerging economies rather than the developed world. Global automotive manufacturers will find, however, that rising global demand brings only limited relief from ongoing commercial pressures. Many will require further radical restructuring in order to increase slim margins resulting from persistent overcapacity.

Key forecasts

▪	The global car market is projected to rise by 13% between 2004 and 2009, to 56m units.
▪	Commercial vehicle sales will continue to rise rapidly, reaching 13m by 2009.
▪	China will grow in importance as a market for motor vehicles, and is expected to overtake Japan as the second-largest market after the US by 2007. Yet this market will suffer significant overcapacity, forcing a shake-out of domestic producers.
▪	The worst commercial pressures are over for the automotive industry, but structural oversupply will continue, resulting in downward pressure on prices. Manufacturers will therefore struggle to raise margins.

 

World Automotive Industrya
	2000	2001	2002	2003	2004	2005	2006	2007	2008	2009
Passenger car registrations (m)	46.4	46.7	46.8	47.6	49.5	50.1	51.2	52.7	54.4	55.8
% change	1.4	0.7	0.2	1.8	3.9	1.2	2.2	3.0	3.0	2.7
Commercial vehicle regstrations (m)	9.1	9.0	9.3	9.6	10.4	10.9	11.3	11.9	12.5	13.2
% change	7.1	-1.7	2.9	4.0	7.8	4.8	3.9	5.1	5.6	5.1
Petrol consumption (m tonnes)	799.8	806.0	811.1	826.7	849.5	869.1	888.6	909.1	929.5	950.6
% change	1.9	0.8	0.6	1.9	2.8	2.3	2.2	2.3	2.2	2.3
Stock of passenger cars (per 1,000 population)	392.0	395.5	401.3	407.8	412.3	415.6	415.9	414.3	412.1	410.6

a 60 countries covered by the Economist Intelligence Unit's industry service. Source: Economist Intelligence Unit.

 
World outlook

The global automotive market expanded strongly during 2004. The Economist Intelligence Unit estimates that total passenger-car sales rose by 1.9m to 49.5m units, a growth rate of 3.9%, broadly in line with our forecasts made in early 2004. This was the fastest annual growth in global automotive sales since 1999. Yet many original equipment manufacturers (OEMs) are still struggling. Sales may have been robust, but this has been achieved at the expense of prices and purchase incentives such as discounts and cheap credit have hit OEM profitability hard.

What's wrong with Detroit's Big Three?

This has increased pressure on the Big Three US manufacturers (General Motors, Ford and DaimlerChrysler) in their home market. Two of the top three car brands in the vital US market are now Japanese, and the Big Three's US market share in 2004 fell a further 1.6 percentage points to under 59% (excluding owned European brands Jaguar, Land Rover, Mercedes, Saab and Volvo). As expected, the US market expanded in 2004 for the first time since 2000, by 1.4%, yet the Big Three producers sold fewer vehicles. Their profits remain under pressure as purchase incentives become ever more generous. As a result, although their combined turnover was in excess of US$500bn in 2004, market capitalisation of the Big Three was only US$93bn in February 2005.

In comparison, Toyota made a net profit of over US$8.5bn in the first three-quarters of the current financial year, has US$32bn in cash reserves and is capitalised at almost US$135bn. While the major US manufacturers have made great progress in recent years to raise productivity and build quality to Japanese standards, market share continues to fall. Their response-to increase purchase incentives through discounting and credit deals-has sapped their margins.

At this stage of the business cycle automotive manufacturers should be making greater profits from their automotive businesses, rather than relying on their finance operations. However, this has not generally been the case for the Big Three.

One factor that has helped the Big Three in recent years is the strength of the market for sports utility vehicles (SUVs), where profit margins tended to be higher than for cars. But even this is starting to change. Rising oil prices threaten to shift the US market away from low fuel-efficiency SUVs to cars.

Passenger-Car Registrations
(m units unless otherwise indicated)
	2000	2001	2002	2003	2004	2005	2006	2007	2008	2009
North America a	18.2	18.0	17.7	17.5	17.7	17.5	17.5	17.6	17.9	18.1
% change	2.8	-1.1	-1.5	-1.3	1.2	-1.1	0.2	0.7	1.3	1.1
Japan	4.3	4.3	4.4	4.5	4.8	4.6	4.6	4.6	4.6	4.6
% change	2.5	0.7	3.5	0.4	6.8	-2.8	-1.6	1.2	0.4	0.2
Western Europe	14.7	14.8	14.3	14.2	14.4	14.4	14.5	14.8	15.0	15.2
% change	-2.1	0.5	-2.9	-1.3	1.6	-0.2	1.1	1.9	1.3	1.4
Transition economies	2.3	2.5	2.5	2.7	2.8	3.0	3.2	3.4	3.6	3.8
% change	-11.7	8.3	1.2	6.8	4.5	5.9	6.2	5.9	6.1	6.7
Asia & Australasia (excl Japan)	4.0	4.1	4.9	6.0	6.5	7.0	7.7	8.5	9.3	10.0
% change	6.4	2.5	17.8	22.9	9.3	7.4	9.4	10.5	9.5	7.3
Latin America	2.2	2.4	2.3	2.2	2.5	2.7	2.8	2.9	3.1	3.2
% change	18.8	5.8	-4.3	-5.0	17.4	8.8	3.7	2.8	4.2	4.2
Middle East & Africa	0.7	0.7	0.6	0.7	0.8	0.9	0.9	0.9	1.0	1.0
% change	9.2	0.6	-4.9	9.3	13.1	10.9	5.5	3.7	2.6	3.3
Worldb	46.4	46.7	46.8	47.6	49.5	50.1	51.2	52.7	54.4	55.8
% change	1.4	0.7	0.2	1.8	3.9	1.2	2.2	3.0	3.0	2.7

a Includes light commercial vehicles. b Sum of 60 countires covered by the Economist Intelligence Unit's Industry Service. Source: Economist Intelligence Unit.

 
Given thin margins and poor profitability on the core automotive-production business, US automotive manufacturers need to see sales volumes continue to rise in the US market during 2005, accompanied by a reduction in the use of incentives. However, we regard these as mutually exclusive; unless manufacturers, led by the domestic Big Three, continue to expand incentives, the market for light vehicles in the US will fall in 2005. Incentives are no longer as effective as they were a few years ago; customers view them as normal. In their absence, demand would be too weak to drive sales volumes upwards.

Regional outlook

North American passenger-car market registrations rose by 1.2% in 2004 as the falling Canadian market, down by 4%, was more than offset by rising US sales. However, we expect sales to fall in 2005 as Canadian demand stagnates and the US market weakens as manufacturers attempt to rein in incentives. Conversely, heavy truck sales are expected to rise. US commercial vehicle sales fell dramatically between 1999 and 2002 as the economy weakened, but as economic activity picked up, truck demand rose, and sales should continue to improve during 2005 and 2006. A lack of late model used trucks will further support new truck sales.

In Western Europe, automotive sales rose by 1.6% in 2004 after declining in 2002 and 2003. Sales were boosted by extra selling days (there were more working days in 2004 than in 2003), new model launches and more generous buyer incentives. However, the improvement in sales growth in 2004 is not expected to persist since consumer confidence remains fragile in western Europe and economic growth weak. Although demand rose in the first half of 2004, new passenger-car registrations fell back later in the year and we expect sales to decline in 2005. Demand should rise slightly in Italy, France and Germany, but falling sales in the once-hot UK and Spanish markets will offset this. Thereafter, the pick-up in west European car sales will be gradual, peaking in 2007 and averaging 1.2% a year over the forecast period. The west European market is not expected to return to its 1999 peak until 2009. Although the worst commercial pressures are behind the major automotive manufacturers, weak pricing and rising incentives are becoming a feature not just of the US but of the European market as well. Rising competition, excess capacity and slack demand in Europe are eroding profit margins and focusing attention on cutting labour costs.

Incentives are rising as manufacturers offer new models and extras to tempt consumers. GM, Ford and Fiat have consistently made losses in Europe in recent years, with no end in sight. A large proportion of 2004 demand growth was captured by Japanese or South Korean manufacturers, whose market share rose 1.2 percentage points to a combined 17.2%. Despite a rising market, many major European manufacturers reported flat or falling sales in Europe in 2004, among them Fiat, Renault, PSA and DaimlerChrysler.

Japanese car registrations rose by 6.8% in 2004, to 4.8m units. This represents the highest level of sales since 1996, boosted by the renewed strength of the Japanese economy after almost a decade of disappointment. However, Japanese GDP growth will decelerate sharply in 2005, and new-car registrations are forecast to decline in 2005 and 2006. Thereafter, sales growth will resume but with the Japanese population ageing and shrinking in numbers, sales growth will be muted.

It is possible that Toyota, which is expected to sell 7.3m units this year, could oust GM (8.7m units) as the world's largest manufacturer of vehicles before the end of the forecast period.

China hits the brakes

With lacklustre sales growth in the mature markets of Europe, Japan and North America over the next five years, emerging markets will account for the majority of the estimated 6m increase in car sales to 2009. Asia, excluding Japan, had been the fastest-growing region for automotive demand with car sales rising over 20% a year in 2002-03. However, after one of the most dramatic and eye-catching growth spurts in the history of automotive demand, the Chinese market has slowed rapidly, and this dragged pan-emerging Asian demand growth down to around 9% in 2004.

In China, passenger-car registrations rose by 70% to over 2m in 2003 and total vehicle sales rose by around 33% to almost 4.5m, making it the third-largest market in the world after the US and Japan. Although, car registrations grew by over 30% in the first half of 2004, since May the market has slowed, rising by only 16% for the year as a whole. Because registrations grew month on month in 2003, base effects explain some of the decline in growth in 2004. Even so, this dramatic slowdown signals significant problems ahead for manufacturers. The most immediate need is to cut production levels to rebalance supply and demand, as inventory levels rose in 2004. But more serious long-term problems will arise from intensifying pricing pressures. The Economist Intelligence Unit always expected prices to fall and margins to be whittled away over time in China, as they had been elsewhere. But the recent market slowdown has accelerated this process, with prices being cut deeper and sooner than many had anticipated. Conversely, falling prices also accentuate the demand slowdown, as consumers hold off purchases in the hope of prices falling still further. Domestic car prices fell by around 10% in 2003 and price cuts accelerated in 2004.

Car sales slowed after signs of overheating in the wider economy forced the government to apply the brakes to credit growth. Bank lending was constrained by a tightening of credit guidelines and increases in reserve requirements. Moreover, domestic banks withdrew from vehicle financing as bad loans rose in a sector with almost non-existent personal credit histories. The market is expected to resume stronger growth in the second half of 2005 and throughout the forecast period, with sales expected to exceed 8m vehicles in 2009. This is 3m more than the current level, meaning that China will account for half of the entire rise in global car demand over the forecast period.

Despite such demand growth, there is likely to be a considerable shake-out in the Chinese automotive sector as oversupply forces a rationalisation of the highly fragmented domestic industry. Currently, only three out of almost 100 domestic manufacturers produce more than 500,000 units a year-Shanghai Automotive Industry Corp (SAIC), First Automotive Works (FAW) and Dongfeng-and each of these has joint ventures with at least two major foreign manufacturers. The remaining domestic companies face an uncertain future as production capacity is added faster than demand can absorb it. Although, their plans are much less certain, companies such as Geely Group, Chery Automobile Company and Brilliance Automotive have ambitious strategies to increase capacity and grab a larger slice of the Chinese automotive market, competing mainly on price. In addition, almost all the world's leading automotive companies have announced plans to expand their presence in China. GM announced in June 2004 that it would invest US$3bn to expand operations with its joint-venture partners by 2007. This represented a further upgrade to already large investment plans, and GM now aims to raise production in China from around 500,000 to 1.3m vehicles a year by 2007.

GM is by no means the only foreign firm with ambitious plans for the Chinese market. The current market leader, Volkswagen, and the Japanese companies Nissan and Toyota have investment plans totalling more than US$10bn. Ford, a relative late entrant to the market, is planning a US$1.5bn investment in a new production facility in Nanjing. These investment plans are adding to a market that already suffers from overcapacity, with utilisation rates low by international standards. The massive investment plans in the pipeline will result in total installed production capacity of between 11m and 13m units by end-2007 compared with a projected market size of 7m. Although, imports will remain on a relatively small scale-even after cuts, tariffs will still average a heady 25% in mid-2006-exports will have to rise dramatically to keep oversupply from damaging profitability.

Yet exports are unlikely to come to the aid of China's car manufacturers; the world automotive industry already suffers from overcapacity, and even with cheap labour the cost of producing cars in China is still relatively expensive. That said, Chery Automotive has announced ambitious plans to raise production from 100,000 units in 2004 to 750,000 units and to develop exports not only to countries like Egypt and Syria but also to the US and Europe from 2007. However, as a company with only seven years of automotive experience, Chery will struggle to succeed in this plan. It will need to develop new engines that comply with strict US and European emission standards and new models, establish dealership networks and compete on price against companies with much larger production runs and associated economies of scale.

Car demand in India will continue to grow robustly

Indian automotive demand has grown rapidly over the last year or so, with passenger-vehicle sales up by 27% to 900,000 units in financial year 2003/04, and commercial vehicle sales rising over 44% to 260,000. Whereas China slowed sharply in 2004, India became the fastest-growing major car market in the world last year, expanding by 24%. In calendar 2004 passenger-car sales exceeded 1m units for the first time as the previous year's bumper harvest raised incomes, and interest rates fell to 30-year lows, allowing attractive finance deals. In addition, the duty on passenger cars and multi-utility vehicles (MUVs) was halved and import duties, although high by world standards, have been reduced. European and US manufacturers have been slow to develop a large presence in India, with the market dominated by Maruti (owned by Suzuki) and a domestic firm, Tata, with a combined market share of more than 60%. Indian roads remain dominated by scooters and motorbikes (6m sold in 2004), but as incomes rise Indians will increasingly aspire to own cars. At six cars per 1,000 population, there is huge potential for car sales growth, provided income levels continue to rise from their relatively low levels. We forecast that the stock of cars will increase to around ten per 1,000 population in 2009 as sales grow by 28% in fiscal 2004/05, 18% in 2005/06 and by almost 10% a year thereafter.

Association of South-East Asian (ASEAN) countries will see solid, if relatively unspectacular, growth in comparison to China and India over the forecast period. However, vehicle sales in the four largest ASEAN markets (Indonesia, Malaysia, Thailand and the Philippines) rose by 20% to over 1.5m units in the 11 months to November 2004. Supported by expansionary monetary policy and improving economic prospects, car sales growth of 17% is estimated in 2004 for the ASEAN region as a whole, falling to less than 6% a year throughout the remainder of the forecast period. In Thailand, the largest automotive market of the four, vehicle sales rose by 17% year on year, to more than 600,000 units, in 2004. However, we expect sales to slow sharply in the first quarter of 2005 owing to weak consumer sentiment following the tsunami in the Indian Ocean in December 2004. Furthermore, demand is likely to be more subdued than in recent years as a result of a modest increase in interest rates and the likelihood that diesel prices will rise after the government abandoned its policy of subsidising fuel prices.

Two local producers, Proton and Perodua (controlled by Toyota), dominate Malaysia, the most protected of the major ASEAN markets. It is the largest market for cars in South-east Asia; pick-up trucks and utility vehicles dominate in Thailand, the Philippines and Indonesia. Sales rose by 18% in 2004 after declining in 2003, but over the forecast period growth will be constrained by the continuing use of tariffs on foreign imports. Sales in South Korea, the second-largest passenger-car market in the region after Japan, fell in 2003 and 2004 to under 1m units as debt-laden consumers limited expenditure. But rising personal wealth on the back of a positive economic outlook (we expect GDP per head to rise to over US$22,000 by 2009) augurs well for domestic car sales in South Korea in the medium term. The relatively stable macroeconomic outlook should also boost sales over the forecast period, since it should allow interest rates to remain low, and by a revival in consumer credit once the excesses of recent years have been worked off. As the depressed economy improves, sales should rise by almost 5% in 2005 and by an average of 7% a year in the four years to 2009.

The Russian car market is ripe for growth

The transition economies of eastern Europe are expected to show healthy growth in car registrations, rising by 5-6% a year over the forecast period, primarily through increased Russian demand. Russia is by far the most important market in the transition region-with sales over four times higher than in Poland, the next largest market. Yet penetration is low, with car ownership running at an estimated 152 per 1,000 of the population, around half the level of Poland, Hungary and the Czech Republic. After slow growth in 2003, Russian registrations rose by 6% in 2004 and are expected to rise by 10% in 2005, supported by high oil prices, rising household incomes and the development of consumer finance schemes. Tariffs on imported second-hand cars and capacity constraints for domestic producers will support demand for imports of foreign-made new cars.

Sales grew rapidly in 2003 in the central European countries of Poland, Slovakia, Hungary, Romania and the Czech Republic, as consumers anticipated price rises once these markets joined the EU in May 2004. In Poland, central Europe's largest car market, sales rose by 16% to over 350,000 in 2003 and continued to increase in the first few months of 2004. But post EU-entry sales have slumped, as second-hand imports rise. Prior to joining the EU, Poland protected new-car sales by requiring second-hand vehicle imports to meet European emission standards for new-car sales by requiring second-hand vehicle imports to meet European emission standards for new vehicles. However, to comply with EU trading regulations this had to be scrapped. Polish consumers imported a record 800,000 used cars in the eight months since EU accession on May 1st 2004. As a result, sales of new vehicles fell by 11% in 2004 and, although increases are expected during the forecast period, sales are not forecast to regain their 1999 peak during the next five years. A similar story is occurring in Hungary and the Czech Republic.

Latin America's automotive industry had been suffering from overcapacity, falling domestic demand and weakness in the US. However, new sales have surged in 2004 and are expected to rise throughout the forecast period, as GDP growth averages better than 3% a year.

Emerging markets will account for the bulk of new sales in the forecast period

In Mexico, the region's second-largest market, passenger-car registrations grew robustly during 2004 and sales are expected to rise steadily, if unspectacularly, during the forecast period, averaging annual growth of 3% in 2005-09. The countries of Mercosur (the southern cone customs union comprising Brazil, Argentina, Uruguay and Paraguay) will contribute almost 500,000 of the 700,000 increase in annual registrations expected in the Latin American region by 2009, when total sales will reach 3.2m vehicles. Improving sentiment in Brazil will be the main driver of growth during this period. Brazil, the largest market in the Latin America region, experienced an almost 10% decline in car registrations in 2003 after the central bank raised interest rates to combat inflation. However, interest rates were subsequently cut and stayed low during 2004, spurring consumer confidence and boosting access to credit. This has allowed a recovery in car demand that resulted in a 16% increase in sales in 2004. Rising real wage growth will support Brazilian car sales, with demand estimated to rise by a further 9% in 2005. The Brazilian automotive industry needs sales to grow at this pace, as the industry was blighted by spare capacity of around 40% in 2003. After a rapid expansion in domestic demand in 2004-05, annual sales growth will slow to 4% over the rest of the forecast period.

In Argentina, vehicle sales doubled in 2004, to reach 295,000, although this is still below the peak of 455,000 achieved in 1999. The protracted economic recession culminating in a sovereign debt default and devaluation caused registrations to collapse to a mere 82,000 in 2002. Sales growth in 2004 represented a rebound from this depressed level, and the rate of increase will not be repeated in 2005. Indeed, unless the supply of credit is significantly improved, sales will not eclipse their 1999 levels during the forecast period.

Sales in Saudi Arabia were rising rapidly on the back of increasing oil revenue, with growth set to continue in 2005, albeit at a slower rate. With oil prices forecast to fall during the rest of the forecast period, growth in car registrations will then decline. South African demand has been boosted of late by rising GDP growth, reduced interest rates and by a cut in the duty on motor vehicles. As a result, 2004 was a record year, with passenger-car sales rising by 18%, as total vehicle sales rose by 22% to reach 450,000. However, average annual growth over the forecast period is expected to be less than 2% owing to slower economic growth, particularly in 2007-09. Rising interest rates will also raise debt-servicing costs at a time when household indebtedness is high.

In summary, we expect vehicle demand growth to slow in 2005 as sales fall in the US and growth in China remains in single figures. Over the remainder of the forecast period, we expect sales growth to accelerate to an annual average of 2.8% in 2006-09. Demand will rise gradually in industrialised countries, but growth will be largely concentrated in the emerging regions, particularly India and China. These markets offer better long-term growth prospects than the saturated traditional markets of the US, western Europe and Japan. However, global oversupply will persist and profit margins, although improving, will remain low.