The Chinese automotive industry, the largest car market in the world, is struggling to deal with a combination of extreme difficulty, including a growing price war and a systemic overcapacity, soaring debt and an imminent global shortage of semiconductors. These complex pressures are not just weakening the sustainability of the industry in the long-term, but they are also rocking international markets as a warning of a decisive moment to both local and global automakers.
State media reports have indicated that Chinese regulators and industry executives have been alarmed with top leaders making commitments to increase regulation of aggressive price-cutting and help the gradual elimination of outdated production capacity. This aggressive position highlights the gravity of the circumstances, which have seen the key financial indicators of most listed automakers decline drastically in the last six years, mostly due to a ruthless price war that started in 2023.
The brutality of this price battle is very clear in the cut-throat tactics used by the major players. China BYD, the largest electric vehicle dealer, made a particularly large-scale cut, reducing prices by up to 34% on some models. This involved lowering the initial cost of its lowest priced model, the battery powered Seagull hatchback, to almost 10,000 dollars, down to 55,800 yuan (7,765), a bold step aimed at competing with its competitors and clearing its overstocking.
The Vicious Price War and Its Consequences
These moves have triggered a ripple effect whereby competitors have been compelled to do the same lest they risk losing market share. As the context explains, when one of the automakers lowers prices to win market share, the others have to do the same – or lose market share. This negative cycle of sharp price reductions of between 15-50 percent is decimating profits throughout the industry, not only to local players, but also forcing foreign brands such as Volkswagen and Mercedes to join the game to stay afloat in China.
The economic cost in the industry is high and it is well demonstrated by LSEG data on the number of 33 listed automakers with headquarters in China. In 2024, the median net profit margin of the sector plummeted to an abysmal 0.83% as compared to 2.7% in 2019. This is a direct result of the stiff competition in the price war eroding the profitability of many firms and thus making it harder and harder to continue operations.
In addition to declining margins, the industry is also facing a major liquidity crunch, especially to suppliers. The mean number of days that carmakers required to pay their suppliers and other short-term creditors increased to 108 days in 2024, as compared to 99 days in 2019. In the case of large brands, the numbers are even more alarming; BYD average payment period has increased to 127 days in 2024 compared to 81 days in 2019, but the company reports that it has decreased to 139 days in 2019. The payment period of Geely Automobile increased to 193 days in 2024 compared to 139 days in 2019, and the payment period of two leading EV brands, Nio Inc and Xpeng Inc, was 223 and 237 days, respectively.
Liquidity Strain and the IOU System
Such a long payment cycle puts an enormous strain on the supply chain, as Joerg Wuttke, Washington-based partner at DGA-Albright Stonebridge Group, pointed out. The new regulation, which became effective on June 1, requiring large companies to pay their suppliers within 60 days, will effectively ensure that these automakers do not turn their suppliers into bankers as Wuttke observed when he noted that, that (new regulation) will enforce a more level playing field. Although Nio and Xpeng have vowed to achieve this 60-day target, the past payment cycles, some of which take more than six months to complete, show the severity of the task.
The use of promissory notes or IOUs also makes the financial situation of suppliers more complicated. Most suppliers in the auto industry in China receive these notes instead of cash, and can be traded or cashed early at a fee in platforms such as BYD DiLian. By May 2023, BYD had issued more than 400 billion yuan (56 billion dollars) of these IOUs which it effectively uses as collateral. This system, which permits larger suppliers to borrow against what they are owed, is a severe strangle of cash flow and stress, particularly in a thin-margin, tight-liquidity environment. The industry is worried about the possibility of a chain reaction on the basis of one missed note payment.
To make the financial health of these companies even more complex are the issues of hidden debt. According to a company that has notoriously sounded the alarm about the problems of Evergrande, GMT Research, the actual net debt of BYD might be up to ¥323 billion ($44 billion)- more than ten times what the company reports and almost half its market value. These obscure character of these commitments, as GMT describes it, “The character of these commitments is uncertain,” casts grave doubts upon the actual monetary soundness of major market participants.
The Zero-Mileage Car Problem and Economic Fallout
Worryingly, to add to these problems, is the practice of zero-mileage cars. These are literally new cars that are registered as sold to dealers or related organizations in order to assist automakers to reach aggressive sales goals and receive government subsidies, and then are transferred to the used car market at high discounts. It is a vicious cycle of inventory laundering a weak demand is covered up, and balance sheets are bolstered, which in turn causes a further decline in prices, which then further justifies production which is in fact too much, which in turn further justifies a low price, which in turn further justifies production which in turn further justifies a low price which in turn further justifies production which in turn further justifies a low price which in turn further justifies production which in turn further justifies a low price. Beijing has specifically demanded the abolition of this practice, as it has been known to distort the market and may be abused through subsidy.
These symptoms are indicative of a greater malady in the Chinese economy than the auto sector itself is suffering. By late 2024, almost a quarter of industrial companies in China, about 23 percent, were making a loss, the worst since 2001. To avoid a mass layoff and loss of revenue, local governments are trying to keep these zombie firms afloat with tax breaks and subsidies due to their heavy debt. But this policy has the unintended consequence of exacerbating the overproduction crisis in China which leaves Beijing in a dilemma: either to fail firms and risk unemployment and social unrest, or to maintain subsidies, which exacerbates the supply glut already troubling the world markets.
Export Shock and Global Trade Repercussions
The effects of the internal economic imbalances in China are gradually overflowing to the international arena. As the economy is generating much more than its local consumers can or will purchase, the pressure to sell surplus products overseas at extremely low prices is enormous. This is what is known as export shock by some people, and it saturates the international market, leaving the local producers in other nations in a situation where they cannot compete with the fake low-cost Chinese exports. This aggressive Sell more, buy less strategy is well demonstrated by the annual balance of trade in China that reached a record of about $1 trillion last year, and that has increased more than 2 times since 2019.
Such aggressive exportation has sparked trade tensions in the world. The negative impact is being felt by countries in India and Brazil, which are investigating Chinese dumping of metal, chemicals and tires, to Mexico, which is accusing the cheap Chinese products of stripping its textile and shoe industries. Even Indonesia is worried about losing jobs in its textile industry and even Russia, a major trading partner has imposed tariffs on Chinese automobiles after they took two-thirds of its market. This shows that the internal auto crisis in China is redefining world supply chains, pricing and the politics of international trade.
The blow to international car manufacturers is a one-two punch. First, the Chinese automakers are reducing prices to an extent that foreign brands such as Toyota and Mercedes are losing their footing and market share even in China itself. Then, the same overcapacity, combined with excess inventory, dumps into world markets, undermining those brands on their own soil, and maybe causing declining profits, plant shutdowns, and job losses worldwide. This is admittedly a big bullet in the chamber of the global trade war, which increases protectionist policies and trade conflicts.
Semiconductor Shortage and Global Supply Chain Vulnerability
To make matters worse, on top of these internal and trade-related issues, the global automotive sector, including the one that functions in China, is now facing another major disruption to the supply chain, a possible semiconductor chip crisis. A conflict between China and the Dutch government that caused the latter to seize control of Chinese-owned chipmaker Nexperia on grounds of technology transfer has seen Nexperia fail to assure chip deliveries. This is a development that has been cautioned by ACEA, the automobile association of Europe, and this may greatly interfere with the production of cars with the U.S. car production being the first to be affected as soon as next month.
Large car manufacturers such as General Motors and Stellantis are keeping a very close eye on the situation with GM CEO Mary Barra saying, “This is an industry problem. Although this can affect the production, our teams are working twenty-four hours with our supply chain partners to reduce potential disruptions. The situation is very fluid.” Major carmakers through the Alliance of Automotive Innovation have called on a swift resolution, with the CEO John Bozzella threatening that a problem in the interconnected automotive supply chain will soon spill over within the U.S. and globally.
These miniature chips, which are the building blocks of automotive parts such as infotainment systems, steering and braking, are indeed capable of creating big issues; the failure of a single diode or chip can stop the production of vehicles. Although automotive suppliers have gone a long way to diversify their supply chains since the 2021 semiconductor shortage, which is also a consequence of the COVID-19 pandemic that has led to higher demand on personal electronics, MEMA association notes that there is still risk. The new chip crisis underlines, also, another aspect of the vulnerability of global supply chain, and the deep interdependencies of the modern automotive industry.
A Struggling Industry in a Changing Global Economy
The problems that the auto industry in China is facing are not just localized market readjustments but rather complex, interrelated crises that serve as a pressure valve to the underlying economic pressures. The unremitting price battle, the spread of concealed debt and fraudulent selling methods, the deep overcapacity with the encouragement of state aid to the so-called zombie companies, and the resulting global export shock are all side effects of a struggling economy trying to reequilibrium. At this point, as the risk of a global semiconductor shortage is added to the equation, the road ahead of automakers, not only in China but also around the world, is becoming more dangerous. These are not just business news of inexpensive cars but signs of a weak global economic environment, where regional turbulence can easily turn into global ones, which all stakeholders should pay close attention to and act with a long-term perspective. The environment is dynamic, the stakes are great, and the automotive industry is admittedly going through a time of uncertainty and change never before seen.
