Mumbai: According to a report on the global economic outlook published by Standard & Poor's Ratings Services in March 2007, global economic growth is disproportionately riding on India and, to an even larger degree, China, both of which have seen energy demand rise sharply.

As the report, titled On The Road To Big Profits In China And India, Global Automakers May Hit Some Bumps points out, automakers' hopes are riding particularly high in China due to the significant investments already made in this market.

Forecasts by J D Power and Associates (which, like Standard & Poor's, is a unit of The McGraw-Hill Companies) suggest that China could overtake Japan to become the world's second-largest automotive market as soon as 2007. It is already the world's fourth-largest manufacturer of automobiles after North America, Western Europe, and Japan, and the third-largest producer of commercial vehicles behind the US and Japan.

However, despite promising high returns, the burgeoning auto markets of China and India carry high credit risks for foreign automakers, not least because of intense competition to maintain a foothold in these markets, says a report published today by Standard & Poor's Ratings Services.

The report points out to the major differences between the Indian and the Chinese markets. In India, the second fastest-growing auto market, passenger cars sales grew by 16 per cent in 2006 compared with just 8 per cent a year earlier, fueled mainly by increases in the small-car segment boosted by tax benefits, new model launches, and greater access to consumer financing. Nevertheless, the international OEMs' chances of gaining from this are being dampened by the predominance of cheaper, locally manufactured motorised three-wheelers, which still hold nearly 80 per cent of India's total vehicle market.

The competition in the Chinese auto industry is more intense than in India, which is still dominated by a few large players, a situation, which the report says, is bound to change as a result of the current attempts of all international OEMs to gain a greater foothold in this market.

In contrast in the more developed Chinese market, every major international manufacturer is already present through imports and, increasingly, with local assembly and production plants, which are generally owned in conjunction with local joint-venture partners.

This has enabled foreign players to capture about 70 per cent of the Chinese market. And. although the country has more than 100 auto manufacturers, only a few companies, including the market leader First Automotive Works Group (FAW), produce more than 500,000 units per year, including commercial vehicles.

On the other hand, the report says, "the fledgling Indian car market" is significantly more concentrated than China's, although foreign players are increasingly making inroads. They are currently working at setting up or expanding their existing production bases in India, but progress is slow and they must avoid the overcapacity already prevailing in China to preserve overall satisfactory profitability in the long run.

Maruti Udyog Ltd, which is 54-per cent owned by Suzuki Motor Corp, dominates with a market share of about 49 per cent. At present, it specialises in the small-car segment, but it has strong plans to penetrate the medium- and large-vehicle segment in the near future.

The next-largest players are Hyundai Motor India Ltd., a subsidiary of Korean Hyundai Motor Co., and India's own Tata Motors Ltd. In the year-to-date November 2006, Tata Motors held third position in midsize entry-level sedans (Indigo) and in the compact-car segment. Finally, Honda Siel Cars India Ltd., a joint venture between Japanese Honda Motor Co. Ltd. and Siel Ltd., is the fourth-largest.

"China represents a major factor in foreign OEMs' profitability expectations, especially those with the largest presence such as Volkswagen and General Motors," said Standard & Poor's credit analyst Maria Bissinger. "It will take longer for the automakers to reap rewards from the Indian auto market, on the other hand, as they are still in the initial stages of the investment cycle."

Competition has severely dented the OEMs' market shares, says the report. That of Germany's Volkswagen AG, which gained almost 60 per cent of the market in the mid-1990s, has fallen to 18 per cent in 2006. Nevertheless, VW's sales in absolute numbers are growing steadily, and the 711,000 units sold by Volkswagen Group in China in 2006 represented 12.4 per cent of the group's global sales volume.

VW made a loss in China in 2005, but recovered to a modest profit of €108 million in 2006. And despite its established production base, investments in China remain high for the group: Between 2007 and 2009, it will invest €1.9 billion in China, although this will be financed from internal funds of its local joint ventures.

Similarly, the book value of investments in China by General Motors Corp, which is number two in the Chinese market through six joint ventures, amounted to about $2.8 billion in the course of the past three years.

Profitability, as measured by GM's share of its Chinese affiliates' net income, amounted to a constant $300 million per year over the past two years, which represents a meaningful contribution to GM's net income of $1.2 billion in the Asia-Pacific region in 2006, and stands in sharp contrast to its huge net loss of $4.6 billion in North America during the same period.

As the Chinese auto market consolidates, the strongest domestic players are already beginning to pose a competitive threat to the established automakers. Already in 2006, export volumes of Chinese-made vehicles (including CKD) reached 340,000 units — although in dollar terms the value of exports still lags.

While China has been the key focus of OEMs' capital expenditures in recent years, the bulk of the production capacity build-up has been completed and fresh investments will be more in the nature of add-ons.

On the other hand, capacity build-up in India will require higher overall investments by foreign OEMs if they want to seriously participate in growth. Furthermore, high import tariffs make local production a prerequisite to reach a meaningful market share in India.

In India, foreign automakers, as well as their domestic competitors, have strong capacity expansion plans. Forecasts suggest that production capacity will increase by more than 80 per cent next three years. This means that the capacity utilisation rate, which was a robust 75 per cent in 2005, is likely to deteriorate significantly until the end of the decade to levels similar to China, currently with capacity utilisation rates somewhat below 60 per cent.

In India and China, with populations of more than a billion each, fewer than 20 in 1,000 driving-age inhabitants owned a car in 2006. This compares with 900 car owners per 1,000 inhabitants in the US. With purchasing power forecast to grow above 10 per cent per year in China and by more than 7 per cent per year in India over the next five years, car sales are expected to grow. enormously.