China’s Automotive Market after the Tax Increase

Ecovis has many clients in the automotive industry. The tax hike on 1st January, 2017, from 5% to 7.5%, caused some confusion among clients about future business prospects. But, as a closer look reveals, the brief decline in car sales in January might rather be explained by consumer anticipation and an early Spring Festival rather than by long-term effects.

China is the world’s biggest automotive market. In 2016, 23.,6 million new cars were registered in the People’s Republic, which is over 6 million more than in the second largest market, the U.S.¹. Regulatory changes and shifts in consumer behaviour thus have a considerable impact on the business outlook of car producers and their suppliers.

Back to normal – China’s slow return to the 10% car sales tax

Recently, China raised the tax rate for small engine cars from 5% to 7.5%. The original tax break – the normal tax rate for private cars being 10% – was introduced in 2015 to support the sluggish car market. Initially, the stimulus was supposed to expire by the end of last year, but in mid-December 2016 China’s Ministry of Finance announced that, instead of an immediate return to 10%, the tax rate would only increase by 2.5 points before reaching the normal level on 1st January, 2018.

For high-priced cars, however, an additional 10%² tax was introduced on 1st December, 2016. This luxury tax includes all cars with a retail price exceeding 1.3 million renminbi, RMB (approx. 189,000 USD).

Over 23.6 million cars were sold in China in 2016.

Although the extension was welcomed by industry representatives, the new year nonetheless saw a slump in small-engine car sales, after 26 years of consecutive expansion. In 2016, car sales had shot up by 13% due to the reduction of the small car sales tax. This growth turned the Chinese into the biggest automobile market in the world.

In the first month of 2017, car sales dropped by 1.1% in comparison to the same period last year³. Because of the new regulations, carmakers’ shares plummeted and a few analysts were quick to blame the tax increase.

However, the drop should not be overrated. In effect, consumer expectations might have caused many buyers to speed up their purchase decision, thus leaving the possibility of the decline being a statistical artifact rather than a real slump. The numbers may also be blurred by the fact that the Lunar New Year holiday fell in January this year, whereas last year it was celebrated in February. A shorter month may have further reduced buying incentives.

China’s automotive market remains strong

There will probably be a period of relative stagnation in the car sales market, because most Chinese customers bought their cars in prior years, anticipating the tax hike. However, this does not necessarily augur a bad time for the Chinese automobile industry, which has been China’s economic linchpin for many years. The industry is big enough to thrive and might see a moderate growth of 3%⁴ this year.

Research⁵ shows that sales in 2015 were boosted way ahead of the news about the incentive. This may indicate that there are some other market forces that are in this case important for demand. One of them may be interest rates which fell notably in 2015 and stimulated the demand for durable goods. Another factor with a positive impact on sales might be better accessibility to loans for automobile purchases that will boost the automotive industry.

These financial reasons may have a greater impact on the car industry than tax regulations. This feature was seen previously in the U.S. automotive market in 1980s, when low interest rates corresponded to increasing car sales, and the same kind of phenomenon might be observed in China in the near future. For these reasons, analysts should also look closely at loan growth and interest rates rather than solely at the tax rate, in order to predict the future of the car market in China.

¹ https://www.statista.com/statistics/269872/largest-automobile-markets-worldwide-based-on-new-car-registrations/
² http://szs.mof.gov.cn/zhengwuxinxi/zhengcefabu/201611/t20161130_2469890.html
³ http://chinaautoweb.com/category/sales/
⁴ https://www.bloomberg.com/news/articles/2016-12-14/china-said-to-plan-extending-auto-sales-tax-incentive-to-2017
⁵ https://www.bloomberg.com/gadfly/articles/2016-12-16/taxes-won-t-kill-china-s-car-sale-boom