China’s car glut went global. Now comes the reset

China's automobile sector faces a potential upheaval as years of overproduction outpace domestic demand, with Toyota's planned merger with Chinese partners serving as a possible harbinger of the forthcoming transformation. This proposed partnership between Guangzhou Automobile Group (GAC) and FAW Group, both state-owned automakers operating separate joint ventures with Toyota, aims to consolidate their operations and combat the industry's excess capacity.

The looming restructuring extends beyond Toyota, as China's automotive industry grapples with an unprecedented glut of production capacity, over 100 competing brands, and a brutal price war that has squeezed profits. Industry experts predict a wave of consolidation across the sector over the next two to three years.

China's automotive production capacity outpaces demand, with the country capable of manufacturing over 55 million vehicles annually, according to Gasgoo Automotive Research Institute data. However, local sales in 2022 were less than half of this figure, with only 8.8 million vehicles sold domestically. To maintain market share, manufacturers have been forced to slash prices, leading to declining profits in the sector.

The excess capacity has also spilled over to global markets, as Chinese automakers aggressively expand their presence in Europe, Southeast Asia, Latin America, and the Middle East. Chinese brands like BYD have seen their exports nearly double in June to over 175,000 vehicles, while domestic sales have declined.

Toyota's China business exemplifies the challenges facing traditional foreign automakers in China. The company's two joint ventures with FAW and GAC have struggled to compete with local brands offering advanced electric and hybrid vehicles. Toyota has already reduced its dealer network in China, with FAW Toyota's stores dropping by 15% and GAC Toyota's by 10%.

The proposed GAC-FAW merger could help address some of these issues by consolidating foreign-brand joint ventures and reducing overlapping investments. However, analysts caution that the broader challenge lies in the loss of relevance of global automakers in the face of rapidly developing Chinese brands.