Will it last?

John Zeng, Director, China Forecasting

20 April 2018

Chinese Trade

The impact of China lifting foreign ownership limits on the auto sector

Following Chinese President Xi’s speech at the Boao Forum on 10 April on deepening reforms and opening up China’s economy, the National Development and Reform Commission (NDRC) released further details of its plans to open up China’s automotive industry. The ministry announced the removal of foreign equity restrictions on special-purpose vehicles and New Energy Vehicles (NEVs) this year, on Commercial Vehicles in 2020 and on Passenger Vehicles in 2022. The rule that currently prohibits foreign automakers from setting up more than two joint ventures in China will also be relaxed. In fact, within the next five years, all restrictions on the industry will have been completely eliminated.

“the NEV segment will be the first to benefit from the elimination of equity restrictions”

In the Passenger Vehicle sector, the NEV segment will be the first to benefit from the elimination of equity restrictions, in accordance with the government’s strategy to promote this sector of the market. Global Electric Vehicle (EV) brand Tesla will be a direct beneficiary as it already has a plan in place to produce vehicles in China, but has struggled to make progress in its negotiations with the government on ownership structure. Traditional brands’ EV production plans will also be impacted, not least BMW, which has already signed a memorandum of understanding with Chinese giant Great Wall, with a view to jointly producing EVs under the BMW nameplate. The new policy could alter the proposed partnership to some extent as the German OEM may wish to increase its equity ratio, or even set up a wholly owned NEV plant itself.

Our view is that this newly announced policy – the full effects of which will be felt five years from now – will impact the traditional sector very differently to the NEV sector. Indeed, the competitive environment will be unlike anything we see today, as EVs will become the industry’s key development focus. In today’s EV market, Chinese brands have the upper hand, compared with their global counterparts, such that the gap between local and foreign companies is not as pronounced as it is in the traditional powertrain sector. In other words, Chinese brands will be well prepared to head off the competition from global automakers once the restrictions on the industry are lifted. This is already evidenced by companies such as VW Group and Ford proactively seeking to collaborate with local entities to ensure that they acquire sufficient NEV credits by 2020.

“Nor would it be wise for foreign OEMs to overlook the influence of their local partners”

Obtaining a production license from a local partner is yet another major hurdle facing foreign OEMs seeking to set up independent operations in China, as the government has stopped issuing any new licenses for the joint production of traditional internal-combustion engine vehicles. Any new manufacturing capacity will only be permitted for NEV production in the future, meaning that if a global brand wishes to obtain a production license to set up a new plant in China, it can only do so if it undertakes to build EVs only.

As for the existing joint ventures, once the equity cap is lifted in 2022, any global brands wishing to part ways with their Chinese partners will be forced to negotiate to secure a production license from their former partners – an achievement that appears to have eluded them so far. Note that most of these joint-venture partnerships renewed their contracts two or three years ago, such that they are now locked in for another 20 to 30 years. For instance, FAW-Volkswagen’s renewal in 2014 means that the contract will remain active until 2040. As any ‘divorce’ within the contract period will be nigh on impossible, renegotiating equity share appears to be a more viable solution.

“any ‘divorce’ within the contract period will be nigh on impossible”

Nor would it be wise for foreign OEMs to overlook the influence of their local partners. For mass brands like Volkswagen and Ford, their joint-venture associates are powerful, state-owned enterprises like SAIC, FAW and Changan. The only way the foreign entities have been able to secure resources and government support in China is through these local partners, so any divorce would effectively leave them vulnerable. With that said, the picture may be somewhat different for some Premium brands as they have traditionally collaborated with smaller local companies, such as Chery (Jaguar Land Rover) and Brilliance (BMW), and the lucrative Premium Car market is a compelling incentive for these foreign automakers to seek full control of their joint-venture partnerships in China.