China Cultivates Taste for German Cars

Source: Wall Street Journal By Vanessa Fuhrmans

As Chinese Drivers Snap Up Germany's Luxury Exports, Berlin Frets That Its Economy Rides Too Much on One Customer

Germany's resurgent export economy is presenting the country's policy makers with a new worry—a growing reliance on China.

Germany's economy expanded at an annualized 9% rate in the second quarter, its strongest pace in more than 25 years.

Driving that growth was demand for German exports, especially from China. Now, however, with China expected to tap the brakes on its double-digit growth in coming months, many economists say the cooldown will have an outsize effect on Germany.

"I see the [Chinese growth] with a lot of mixed feelings," said Ralph Wiechers, chief economist at the VDMA German engineering federation. "On one hand, it is clear that China is ever more important for German companies. But as a businessman, you always wish that your growth was broader-based."

German export gains in China—55% in the first five months of the year, or roughly six times the growth rate of exports to the euro zone—have been the primary engine in the recovery of many German manufacturers, such as textile machinery, compressor and machine-tool makers.

For German machinery makers—a pillar of the country's economy—China last year surpassed the U.S. as the largest export market, with some 10.2% of their exported products flowing there, compared with 7.2% going to the U.S.

During the first five months of this year, the share of German machinery production headed to the China grew even further to 11.1%.

Across Germany's broader economy, China represents about 5% of all German exports, half the volume of exports to France, Germany's largest, single export market, and a small fraction of those to the entire euro zone.

Nevertheless, China's predominance as a driver of German growth is unlikely to change soon, with much of Europe stagnating and the U.S. outlook uncertain.

China's growth softened over the second quarter, to 10.3% from 11.9% in the first quarter, and economists predict further slowing as the government restrains bank lending in an effort to keep the economy from overheating.

Though German industry as a whole has benefited from exports to China, the country's marquee sector—autos—has profited most.

Among Germany's big premium car makers—BMW AG, Daimler AG's Mercedes-Benz and Volkswagen AG's Audi—individual car sales to China have soared between 63% and 132% so far this year.

Such growth has fueled a surge in profits, pushing operating margins to record levels despite weak sales on their home turf in Europe and spotty growth in the U.S.

Behind the windfall is a confluence of factors. Chinese luxury-car drivers gravitate toward pricier, higher-end vehicles with much bigger engines and more options than such buyers in the three auto makers' more mature markets.

The euro's roughly 15% slide against the dollar and the Chinese yuan in the first half of 2010 added another boost to profit margins on cars imported from Germany or elsewhere.

As a result, analysts estimate that the German auto makers of late, particularly BMW and Mercedes, may have been reaping as much as €30,000 ($38,613) in profit per car exported to and sold in China. That is roughly 10 times the amount the car makers typically get in Europe.

At BMW, Chinese profitability may have contributed as much as 90% of the car maker's €1.3 billion in second-quarter operating profit from its auto segment, estimates Max Warburton of Bernstein Research in London.

Such lopsided fortunes have some economists and industrialists fretting that Germany's auto industry is becoming too reliant on Chinese growth and that such exposure is a harbinger for other swaths of Germany's export-driven economy.

"What makes me worried is that it is just such unsustainably explosive growth," said Bernstein's Mr. Warburton.

He added that the remarkable Chinese profitability of German car makers presents a "potentially misleading picture" of the companies' financial health as they struggle with overcapacity, growing investment costs in fuel-efficient technologies and minimal growth in other big markets.

"I've got a horrible feeling there will be a few setbacks" as China's car market develops, he added.

This week, a key monthly index of German investor confidence, conducted by the ZEW Center for European Economic Research, showed that investor sentiment dropped to a lower-than-expected 14.0 in August from 21.2 in July.

Those data suggest a more pessimistic outlook for export-led growth the rest of the year after strong German economic growth during the first half of 2010.

In addition to slowing manufacturing growth in China, factory orders in the U.S. dropped more than expected in June, the second monthly decline in a row and a further sign the U.S economy might be weakening.

Meanwhile, growth in the euro zone isn't expected to accelerate anytime soon as European governments implement austerity measures to tackle budge deficits, and German consumer spending remains sluggish.

German auto makers dismiss the notion that they have become too dependent on China for growth, even as they shift resources and ramp up production to meet Asian demand.

"It is important to me to emphasize we are not solely relying on China," BMW's chief executive Norbert Reithofer said this month, when the auto maker presented its second-quarter earnings.

"We are a company that acts and operates globally," Mr. Reit-hofer said.

Other vehicle makers have already begun managing expectations for slower growth world-wide.

In announcing Volkwagen's July car sales last week, the company's sales chief Christian Klingler predicted that the global auto market would shrink in the second half, suggesting that growth from China and other emerging markets wouldn't be enough to offset declining sales in Europe and elsewhere.

"There will not be a return to precrisis levels this year," Mr. Klingler said.