On 1 January 2017, China has raised the tax rate for small cars from 5% to 7.5%. The original tax break – the normal tax rate for private cars being 10% - was introduced in 2015 to support the sluggish car market. Initially, the stimulus was supposed to expire at the end of last year, but in mid-December 2016 China's Ministry of Finance announced that instead of an immediate return to 10%, the tax rate would only increase by 2.5 points before reaching the normal level on 1 January 2018.
For high-priced cars, however, an additional 10% tax was introduced on 1 December 2016. This luxury tax includes all cars, whose retail price exceeds 1.3 mil RMB.
Although the extension was welcomed by industry representatives, the New Year brought nonetheless a slump in small-engines car sales, after 26 years of consecutive expansion. In 2016, car sales had shot up by 13% due to the reduction of small car sales tax. This growth turned the Chinese automobile market become the biggest market in the world.
Comparing to the same time last year, car sales dropped by 1.1%. Because of the new regulations, carmakers’ shares plummeted and some of the Chinese top automobile manufacturers’ shares have declined by a few percent.
However, the drop should not be overrated. In effect, consumer expectations might have caused many buyers to speed up their purchase decision, thus leaving the possibility of the decline being a statistical artifact rather than a real slump. The numbers may also be blurred by the fact that the Lunar New Year holiday fell in January this year, whereas the last year it was celebrated in February. A shorter month may have further reduced buying incentives.
There will likely be a period of stagnation in the car sales market, because most Chinese customers bought their cars in the previous years, anticipating the tax hike, but it does not necessarily augur a bad time for the Chinese automobile industry, which has been China’s economic linchpin for many years. The industry is big enough to thrive and might see a moderate growth of 3% this year.
Research shows that sales in 2015 have boosted way ahead of the news about the incentive. This may indicate that there are some other market forces that are in this case important for the demand. One of them may be interest rates which fell notably in 2015 and stimulated the demand for durable goods. Another factor with a positive impact on sales may be a better accessibility to loans for automobile purchases that will boost the automotive industry.
These financial reasons may have a greater impact on the car industry than tax regulations. It has been seen previously in the U.S. automotive market in the 1980s, when low-interest rates corresponded to increasing car sales and the same kind of phenomenon might be observed in China in the near future. For those reasons, analysts should also look closely at loan growth and interest rates rather than solely at the tax rate, in order to predict the future of the car market in China.
With support by Zuzanna Szubartowska
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