Car sales party seen winding down with expiry of tax cut

Automakers partying to record sales in China this year are set for a reckoning in 2017, with deliveries poised to expand at a third of this year's pace. The reason: an increase in a sales tax affecting the biggest segment of the world's largest auto market.

China raised the sales levy on small-engine cars to 7.5 percent on Thursday, curbing an incentive that has propped up the industry that's headed for its 26th consecutive annual expansion. While the tax rate is less than the 10 percent originally scheduled to take effect from January, it is still an increase from the 5 percent rate introduced in October 2015.

The tax reduction can translate to savings equivalent to a few months of gasoline on a new 119,800 yuan ($17,350) Ford Escort sedan, prompting buyers of small-engine cars to bring forward their purchases ahead of the expiration of the tax cut at the end of this year. Vehicles deliveries are on track to rise at least 13 percent in 2016, according to the China Association of Automobile Manufacturers. The increase in deliveries will slow to a range of 4 percent to 5 percent next year, based on the average of four estimates by analysts and industry association officials compiled by Bloomberg.

"By setting the rate at 7.5 percent, instead of having it snap back to 10 percent, the government is providing a cushion for sales to slow down without a crash landing," said Yale Zhang, managing director at researcher Autoforesight Shanghai Co. "They don't want to see more congested cities with people buying all these new cars."

The tax hangover will affect Geely Automobile Holdings Ltd and Great Wall Motor Co disproportionately given the majority of their sales are small-engine cars, according to Sanford C Bernstein analyst Robin Zhu. Geely posted the fastest sales growth among major local automakers with its deliveries almost doubling to 102,422 units in November, while Guangzhou Automobile Group Co and Great Wall recorded sales increases of more than 30 percent last month.

A measure of Chinese mainland automakers traded in Hong Kong slumped for a second day after Bloomberg reported on the planned tax increase.

Foreign carmakers will also be hit by a softening in demand. General Motors Co and Volkswagen AG count China as their biggest market for sales.

"Mass-market carmakers like GM and VW will be more affected than luxury ones like BMW and Mercedes," said Arndt Ellinghorst, a London-based analyst for Evercore ISI. "There might be some weakness early next year after some consumers bought early to still benefit from the incentive."

Representatives for GM, VW, Daimler AG and Fiat Chrysler Automobiles NV declined to comment on the impact of an increase in the sales tax before an official announcement. Geely and Great Wall didn't immediately respond to requests for comment.

Ford is preparing for different tax scenarios and would like to see the tax incentive "continue in some form," said Mark Truby, a company spokesman.

Chinese consumers bought 21.1 million passenger vehicles in the first 11 months of the year, more than the 20.6 million units purchased in all of 2015, according to the China Passenger Car Association. The last time China's car market shrank was in 1990.

"The consensus of 4 percent sales growth in China next year seems optimistic to me," said Matthew Stover, an analyst with Susquehanna Financial Group in Boston. "People expected these tax policies to expire so there's been an acceleration of people buying, a pull ahead of demand."