Too Much, Too Soon? — page 2

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.

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