However, this policy indeed helped the entry B-segment grow quickly to more than 40 per cent year-over-year. The C-segment jumped by 50 per cent till June. Meanwhile, the D-segment showed strong growth as well, after two years of sluggish performance due to some major new product launches, such as Toyota Camry and Reiz.

With the economy growing quickly in 2006, institutional buyers also recovered from 2004 restraints and started to buy.

The second half of 2006 does not seem to be as optimistic as it was in the first six months. One of the most obvious reasons is that the second half of 2005 was very strong. The gasoline price jumped to 5.1 yuan per litre on 24 May, 2006, though not significantly enough to impact the market directly; this puts pressure on OEMs to cut prices more frequently than before.

Price cuts started in January and significantly accelerated in the second quarter, especially from the end of May. Toyota's Camry is another major reason for late-May's price cut frenzy. There are 26 new models to be launched for the second half and there is the potential danger that the rising gasoline price and too many new models intertwined together will cause a similar price war as happened in 2004.

Recently there have been more price reductions, but luckily no price war.

Policy

In January 2006, the central government requested all local cities cancel their traffic control over mini cars, usually those 1L or below. This change will benefit not only those with less than 1.0-litre engine cars but also those 1.0L-1.3L cars.

Many customers in China worry that when the car population becomes larger in the city, the city government will raise the threshold of banning small cars from 1L to 1.3L or even 1.4L. Therefore, many customers would rather choose to save more money to buy a larger vehicle to be "safer" against the possible local traffic controls. Now consumption confidence has become very strong toward a wide range of small cars.

Many cities have strengthened their control over older vehicles that cannot meet the country's Euro I emission standards.

Euro I standards have been applied since January 1999 in Beijing and mid-2000 nationwide. Now Euro I is the lowest acceptable emission standard in China. Cars that cannot meet Euro I will be banned from driving in the downtown area or even the whole city. This policy is largely a by-product of releasing control of mini cars.

Local cities would like to use this method to enhance the city environment and control the total number of vehicles driving in the downtown area. The result, however, can be a catalyst for triggering replacement of old carburetor-engine cars and therefore quickly pushing extra demand in 2006.

In July, the central government postponed the second phase of "Import Kit Management Rules" by two years. The postponing is going to benefit luxury car-makers and accelerate the launch of new models in the coming two years.

Supply

China's market is closely related to new product launches. OEMs (original equipment manufacturers) launched and will launch a total of 46 new models to the market in 2006; these new models effectively contributed to incremental volume. More than 15 new models since late-2005 and early 2006 ignited the C-segment.

Meanwhile, more and more local OEMs started to offer very affordable products such as Chery Qiyun and FYD F3. Local OEMs grew quickly, especially Chery, due to its new Qiyun series. The phasing out of the old Fengyun series and the lower price of the Qiyun compared to the Fengyun's price level instantly ignited demand, especially in inland provinces.

Shanghai GM performed very well thanks to its Buick Excelle. Volume for the Excelle was boosted by its hatchback HRV and its new wagon version. Toyota finally launched its most important model, the new Camry in Guangzhou. Production is now in high gear due to strong demand.

The production trend nowadays is still polarized as some of the top OEMs such as Chery, General Motors and Hyundai are using up capacity and have to expand. On the other hand, smaller OEMs such as Jiangnan or Lifan still contribute a lot of empty capacity.

Among the local OEMs, the situation is also now quite polarized. Chery and Geely grew quickly due to mature products and strong marketing. For the newer OEMs, the market leaves less and less time for growth. If the very first product sells well, the whole operation will enter a brand new page. Otherwise, the pressure may crush some of the smaller automakers such as Aux and Huaxiang Fuqi.

This pressure, however, may very well explain the fervor of going abroad for those smaller car-makers such as Zhongxing and Lifan. The pressure for survival pushes the OEMs to do anything to enlarge their sales and production. Therefore, we see most of the small local OEMs in China may anxiously want to export, including Geely in its early days and Lifan currently. However, Chery and today's Geely are different. They start to think about the global market strategically instead of merely trying to relieve some of the survival pressure.

2007 Outlook

Market development in 2005 and 2006 opened a road to the vast inland cities. Since early-2005, the inland market has overtaken large coastal cities to become the major growth for passenger car demand, which enables a sustainable long-term growth pattern and good sales of local brands' entry-level B- and C-segment cars. The real city individuals, instead of institutional buyers or private business owners, started to buy cars for family purposes. Once the huge inland market is explored, if there is no unexpected negative factors, the year 2007 will see steady market growth again.

Though 46 new models in 2006 are surprising, 2007 will be another record year for new model launches. There will be around 52 new models entering the market. More interestingly, these 2007 new models will mainly come from local OEMs. In 2005 and 2006, foreign OEMs were the stars in new product launches. From 2007, these foreign OEMs will start to change the model generation; there are not as many whole new models because their product lines have been filled until now.

Will local models effectively stimulate demand in 2007? The answer should be quite positive. As we already observed that demand is now shifting to inland markets, local brands have the advantage to penetrate even deeper than foreign models. Inland private buyers pay more attention to price than their counterparts in the coastal regions.

The hot sales of BYD F3 and Chery New Qiyun are both good examples. In the B-segment, Chery's M11 and Changan CV7 can be very good examples with Changan's CV6 "Benben" and Great Wall mini car in the A-segment. This kind of affordable new local product is set to push or stimulate inland 2-tier or 3-tier cities in 2007.

Other than local OEMs, foreign OEMs will also launch some important new models. Toyota will launch the new Corolla in May and Ford Mondeo will change to a new generation, as will the Suzuki Alto.

Of course, new products are always double-edged swords. Too many new models will put pressure on current models and may result in a stability problem of the current price structure. Steady price reduction is one people can foresee and will not cause problems. However, if there is a price war, the situation will become very different. The last thing we want to see is a repeat of the 2004 slowdown.

Another major negative factor now is gasoline price. The retail price jumped to 5.1 yuan/litre in May in Beijing, and the NDRC has not reduced it after the international crude oil price dropped from US$80 per barrel to US$60 per barrel. With the international price at a low level, the NDRC has no reason to hold the retail gasoline price that high. Therefore, at least for early-2007, the gasoline price issue should not be a major problem.

(China Daily 11/18/2006 page15)