China's eastern coastal provinces of Zhejiang and Jiangsu are considered the main growth areas for luxury cars, but the area is currently riddled with pyramid schemes, slush funds and bankruptcies, raising questions about future luxury car growth in the area.
IHS Global Insight Perspective | |
Significance | In the eastern coastal provinces of Zhejiang and Jiangsu bankrupt business owners have disappeared, leaving behind huge debts with suicides on the rise; meanwhile apartment blocks in villages remain empty and slush funds used to facilitate purchases of luxury cars are drying up. |
Implications | China's huge surge in sales of luxury cars in the eastern coastal regions was funded by businesses enjoying large growth from exports and domestic sales, but as export markets for consumer products fall these businesses are becoming bankrupt, bringing down with them the private lenders and the slush funds that helped them grow. |
Outlook | It is as yet unknown how strong the ripple effect will be from the bankruptcies originating in China's eastern coastal area, a region known as the main stronghold for luxury and super luxury cars. |
In the eastern coastal province of Zhejiang, home to the largest number of luxury car dealerships in China, a spate of bankruptcies threatens to upset growth in luxury car sales in the region. The total extent of the ripple effect of the bankruptcies is currently unknown.
In July, underground banks in Zhejiang's city of Wenzhou processed CNY110 billion (USD17.3 billion), up about 40% from the CNY80 billion processed in the same month a year earlier and equal to more than one-third of the city's entire 2010 GDP of CNY292.56 billion, according to the Wenzhou branch of the People's Bank of China.
Chinese small enterprises have generally preferred to borrow from private lenders and underground banks. State-owned banks have seen a number of interest rate rises this year, further pushing small business owners to look for funds underground. As businesses have begun to hit bankruptcy, often fuelled by the lack of demand in developed markets, some 29 business owners have disappeared from Wenzhou, leaving behind a trail of debt, according to state-owned media outlet Xinhua. These 29 businesses are all CNY100-million businesses.
Meanwhile, shadow banking has also affected luxury car sales. The government is calling for tighter restrictions to control the amount of shadow banking that takes place. Liu Mingkang, chairman of the China Banking Regulatory Commission (CBRC), says that the CBRC has been closely monitoring China's local financing vehicles and working with local governments to help them manage their debts. According to the National Audit Office in June, local government debt totalled CNY10.72 trillion at the end of 2010. Banks have been ordered to refrain from providing loans to local governments for unapproved projects and vehicles and to tighten credit management in order to prevent debt increases, Liu said.
Chinese premier Wen Jiabao has this month (October) raised the issue, calling for a stop to illegal lending and more help to small businesses, especially in the Wenzhou area. "Effective measures should be taken to contain the trend of usury, crack down on illegal fundraising and properly handle the problems of collateral and capital shortage in order to prevent risks from spreading and evolving on a regional scale," he said, as reported in the China Daily. In Wenzhou, one-fifth of the city's 360,000 small and mid-sized businesses have stopped operating because of cash shortages, according to the city's council for small and mid-sized enterprises in October 2011.
Outlook and Implications
So what does all this mean for the luxury car market? Zhejiang and Jiangsu provinces are near Shanghai and are coastal provinces. These areas have recorded strong growth in the last few years, resulting in a concentration of wealth. Zhejiang province has the highest number of premium dealerships—BMW has 28 in the province, while Audi has 21. Jiangsu province follows—BMW has 26 dealers here, while Audi has 19. In Zhejiang province the cities of Hangzhou and Wenzhou stand out with the largest number of dealerships. BMW and Audi have four dealerships each in Hangzhou and three each in Wenzhou (For further details please see the Special Report: China's Premium Car Market Set for Huge Growth).
The ripple effects of the bankruptcies are already being felt. An article by the Shanghai correspondent of the Telegraph illustrates the situation by profiling a village in east China that overnight became a hub for BMW cars. A huge pyramid borrowing scheme saw local people trapped into investing their life savings in a property complex that today lies empty. The only BMW cars left are now those sat outside government offices; the schemers are in prison or under house arrest.
Yet IHS Automotive analysts say that while the effect of the bankruptcies and illegal slush funds will affect premium car sales in the region, the extent of the ripple effect across the country is currently unknown. It remains to be seen whether large numbers of bankruptcies are filtering through to other areas and whether interest rates at illegal loan funds are causing problems in other provinces. The situation is being closely monitored by the government. Nevertheless, Zhejiang and Jiangsu are both being hit hard by the sudden bankruptcies and this will hurt the growth of premium cars in the region.
IHS Automotive's light vehicle forecast manager Lin Huaibin says that in 2010 a total 151,912 units were sold in the Wenzhou area. Wenzhou area sales were expected to grow by 16% year-on-year in 2011, of which 15% of the growth was forecast to come from luxury car sales. Luxury car sales in Wenzhou are therefore forecast to around 26,432 units this year. However, the bankruptcies and related issues in the area next year could see a sudden drop in sales of luxury cars in the region. "For 2012, we can assume an extreme case: half of those luxury car sales in 2011 might disappear due to the local credit crunch, the luxury car sales lost would be 13,216 units," says Lin. Overall, however, China's premium car sales are expected to hit 1.14 million units in 2012, so the impact of what is happening in the immediate Wenzhou area is minimal as growth in other areas will lift sales. The government is pushing growth in the western regions of the country and this may limit the effect of the downward spiral of the Wenzhou area. Premium car makers are already expanding dealerships in the western areas of China (see China: 19 September 2011: Chengdu Auto Show: Mercedes and Porsche Increase Line-Up in Western China's Main Auto Show).
If the situation should spread, however, the ripple effects could then have a more severe implication for premium and luxury car sales often bought as a way of showing friends and families that business is exceptionally strong. Yet the realities of businesses failing are not easily dealt with for many in China, and the issue of "face" often means suicides are the chosen method to avoid confrontation. Chinese media report that these have been on the rise in the Wenzhou area in recent weeks.