Cars and the World Economy Auto Sector Puts Brakes on World GDP Growth Highlights

• Recent auto sector weakness has reduced world GDP by 0.2%

• Key driver of global industrial downturn

• Auto exposure explains pattern of recent negative GDP surprises

• Strong multiplier effects to other sectors through supply-chains

• Global demand should stabilise this year, helped by China policy cycle

• But no rapid rebound; weakness will continue to weigh on global manufacturing

• Structural demand headwinds including environmental concerns, saturation

• Auto tariff increases still a risk and would materially harm global growth

www.fitchratings.com | May 2019 Car Trouble Weakness in the global automobile market has had a material impact on world economic growth over the last nine months or so and has played a central role in the sharp downturn in the global industrial production cycle. The relative exposure of economies to the auto sector helps explain the geographical pattern of recent growth disappointments – specifically the large negative GDP surprises in Germany in late 2018. There is substantive research showing that multiplier effects from changes in auto demand on the output of other industries are powerful. Prospects for the auto sector therefore appear particularly important for the global macro outlook at this juncture and are the focus of this special report from Fitch Ratings’ economics team. It is likely that global auto sales will stabilise in 2019. The impact of vehicle tax rises in China in 2018 will fade and some modest policy support measures are likely later this year. Weakness in European sales in late 2018 partly reflected the temporary impact of the transition to new fuel emission standards. The upturn in China’s credit cycle and the recent shift to a more accommodative global monetary policy outlook should also help auto demand at the margin. But with evidence of significant recent inventory accumulation in China and Europe, the rebound in auto production is unlikely to be rapid. A flat auto market will continue to dampen global manufacturing indicators, particularly in the eurozone. Moreover, several structural headwinds for auto demand look set to persist including increased environmental concerns about diesel cars and the emergence of new modes of auto travel (ride-hailing and car- sharing), which could ultimately reduce the desired size of the vehicle fleet. Car markets in the U.S. and western Europe have also likely reached close to saturation levels – limiting the scope for further sales expansion – and used cars are becoming more popular in China. The risk of increased tariffs on global auto trade remains real and would be a significant drag on global GDP if it were to materialize.

World Passenger Car Output and Global Industrial Production

(% yoy) World Industrial Production (CPB) World Auto Production* 25 20 15 10 5 0 -5 -10 -15 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018E * Auto production includes light trucks for the US Source: Fitch Ratings, CPB, OICA

www.fitchratings.com | May 2019 3 From Global Growth Leader to Stagnation Annual Change in World Auto Sales Global auto demand is estimated to have declined in 2018 for the first China US (BEA)* time since 2009. While the decline looks to have been quite modest at less Japan UK than 100,000 units, the swing from an average annual increase of close Eurozone Big 4 Brazil + Russia + India Rest of Wolrd World * to three million units a year over 2011 to 2017 was sharp. Demand fell by 0.1% in 2018, compared to average annual increase of 4.1% over 2011 to 10 2017. Our estimate of global sales in 2018 – details of which are discussed 8 below – is just below 82 million units. This is 50% higher than sales in 6 2009 highlighting how auto demand had been, at least until recently, far 4 outstripping global GDP (the latter has increased by 30% since 2009). The 2 boost to global demand in recent years has been compounded by the shift 0 to more expensive vehicles (SUVs) in advanced economies.

-2Units) (Million Given the multitude of data sources on the sector it is helpful to clarify -4 the numbers we have used to analyse trends in the global auto market. -6 Our estimates of global auto sales are based on data for global sales of new of passenger cars from the International Organisation of Motor -8 2006 2008 2010 2012 2014 2016 2018E Vehicle Manufacturers (OICA) adjusted to also include light trucks (SUVs and pick-up trucks) in the US, where they account for a majority of new *US data include light trucks sales. OICA only publishes global sales data until 2017 but we have Source: Fitch Ratings, OICA, US BEA, Haver Analytics used monthly figures from national sources on new car registrations to update 2018 sales data for the largest 13 markets. For the other smaller markets combined, we have assumed that growth in 2018 was the same as in 2017 at 3.6%. This is perhaps a little optimistic and it is possible that World Auto Sales our estimate for global sales in 2018 is too high, given that these smaller China US (BEA)* markets combined accounted for 18% of total sales in 2017. Japan UK Eurozone Big 4 Brazil + Russia + India A cursory glance at the second chart reveals the dominant role played by Rest of Wolrd World * China in the dynamics of the global auto market. China has accounted 100 for half of the total growth in global car sales since 2009 and in 2015 and 2016 provided almost 90% of the expansion in world sales. Chinese sales 80 grew by 1.8 million a year over 2009 to 2017 compared to global sales growth of 3.4 million a year. However sales in China started to tail off in 60 early 2017 and then fell sharply from mid-2018. Over 2018 as a whole, passenger registrations were down by just over one million to 24 million. 40 This fall of 4.3% was a dramatic change in trend following annual average

(Million Units) (Million sales growth in China of 12% over 2010 to 2017. 20 There was insufficient demand growth elsewhere to offset the fallin Chinese sales last year. U.S. sales have been broadly flat at around 17 0 million since early 2015. While 2018 was a marginally better year than 2006 2008 2010 2012 2014 2016 2018E 2017 – when US sales fell by 2% – the expansion was only modest at 0.3%, equivalent to 50,000 units. Eurozone sales registered positive *US data include light trucks growth for the year as a whole (up by over 100,000 units) but this was Source: Fitch Ratings, OICA, US BEA, Haver Analytics at a much slower pace of expansion than in 2016 and 2017, reflecting a sharp fall in sales in the last four months of the year. Meanwhile, sales in Japan – the third-largest national market – were flat and the UK recorded Monthly Car Registrations - Seasonally Adjusted a second consecutive year of declining registrations. The only bright spot was in other emerging markets – sales in Brazil, Russia and India US Eurozone combined have been rising strongly since mid-2017 and were up by China UK nearly 600,000 units in 2018. Sales in these countries are likely, however, Japan Brazil + Russia + India to entail lower value added per unit in dollar terms. 2500

2000

1500

1000

(Monthly, 000's) 500

0 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

Source: Fitch Ratings, BEA, SMMT, JAMA, CAAM, ECB, Anfavea, SIAM, AEBRUS, Datastream

www.fitchratings.com | May 2019 4 Autos Impact on Wider Economy Car Output and World Industrial Production The turnaround in global car sales has taken a toll on world growth. A very World Industrial Production (LHS) crude back-of-the-envelope calculation – assuming an average global Global Car Production Monthly Proxy* (% yoy) (% yoy, new car price of USD15,000 – would put the dollar value of 82 million 3m.m.a.) units of annual global new car sales at USD1,200 billion. This figure (which ignores the value of ancillary financial and other services typically 9 30 8 associated with car sales) is equivalent to a mid-to-large eurozone 7 25 economy, such as Spain, or a large emerging market, such as Indonesia 6 20 or Mexico. Had a national economy of this size seen the sort of growth 5 4 15 dynamics recently witnessed in the auto market it would certainly be 3 10 attracting attention among global economy watchers. 2 1 5 But aside from scale, several other factors underline the importance of 0 0 the auto sector, including its high correlation with the global industrial -1 cycle, the clear link between recent GDP surprises and the relative -2 -5 -3 -10 exposure of economies to autos, and the sector’s large multiplier effects on other industries. Certainly, the sensitivity of political leaders and policy

2011 2012 2013 2014 2015 2016 2017 2018 2019 makers to a sector frequently perceived to be systemically important is in little doubt. This is evidenced by the bail-out of GM and Chrysler by *Weighted average of US, eurozone, UK, Japan, China, Korea the US government in 2008, direct state intervention to support PSA Source: Fitch Ratings, National and Industry Sources, CPB, Datastream in France and Avotaz in Russia, and the widespread roll-out of ‘cash-for- clunkers’ programs in the aftermath of the global financial crisis. The first chart in this report shows a very strong correlation between global World Auto Production auto production and global industrial production growth. This is significant given that industrial production and manufacturing indicators have seen China US* Japan a much sharper deterioration than global service sector indicators over Germany India Korea the last six to nine months. (Note that the annual global car production Brazil Other World numbers used in the chart have been put together in a similar way to 90 the sales data – i.e. using OICA passenger car output data adjusted by 80 replacing the data for the U.S. with BEA figures on cars and light trucks.) 70 While the estimated 2.4% dip in world car production in 2018 was not 60 accompanied by a simultaneous decline in global industrial production 50 growth on an annual basis, this seems to be just a matter of timing. 5.1 Global industrial production held up well in early 2018 before tailing off 40 8.4 (Million Units) (Million sharply in the latter half of the year – annual average global industrial 30 11.0 production growth looks sure to fall quite significantly this year. Indeed, 20 the subsequent chart shows that a monthly proxy for global auto 10 23.5 production – based on a weighted average of production growth in 0 China, the U.S., Japan, the eurozone, the UK and Korea – leads the cycle in world industrial production growth by about six to 12 months. 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

2018E Countries with larger exposures to global auto demand have seen some of *US data include light trucks Source: Fitch Ratings, OICA, US BEA, Haver Analytics the biggest recent disappointments in macro-economic data. OECD data show that the share of whole economy value added (sales minus the cost of intermediate inputs) in automobile production is far and away the highest in Germany among the large OECD economies, followed by Mexico and Auto Sector Value Added Korea. Germany saw the biggest negative surprises in GDP growth relative to expectations in late 2018 and both Korea and Mexico suffered unexpected 5.0 declines in GDP in 1Q19. It is also clear given the high share of auto sector 4.5 exports in GDP and large auto trade surpluses that these three countries 4.0 are very much exposed to global trends in auto demand. The deterioration 3.5 in manufacturing PMIs through the second half of 2018 was also more pronounced in countries with a high share of auto exports in GDP. 3.0 2.5 Demand shocks in the auto sector have particularly strong impacts on the rest of the economy thanks to upstream supply-chain linkages as 2.0 auto makers shift their demand for steel, glass, rubber, components and (% of GDP, 2017) 1.5 so on. This is evidenced by Eurostat estimates of ‘output multipliers’ for 1.0 different sectors of the EU economy derived from input-output accounts, 0.5 which detail the supply-chain linkages between different industries. Output multipliers show the effect of a unit increase in final demand in 0.0 a particular sector on overall economic output once the indirect impacts UK

US through higher demand for upstream supplier-industries’ output is taken Italy Korea Spain

Japan into account. Eurostat research finds a multiplier of 2.4 for motor vehicles. France Poland Mexico Canada Germany Australia This is higher than for EU industrial manufacturing as whole, which in turn

Switzerland has the highest output multiplier among the broad sector categories. Source: Fitch Ratings, OECD

www.fitchratings.com | May 2019 5 In a similar vein, recent research published by the St Louis Fed has Auto Trade as % of GDP in 2017 highlighted the role of the auto industry as a hub for U.S. industry, with powerful spillovers to other industries. This research cites other (% of GDP) Auto Exports Auto Trade Balance academic evidence suggesting that industry-specific shocks can explain as much as half of the overall fluctuations in the U.S. economy. Another 7 way of illustrating the importance of these spillovers from shocks to 6 auto demand is to look at the share of the sector’s gross output (gross 5 revenue from final sales) that is spent on purchasing intermediate 4 inputs from upstream supplier industries. According to the BEA’s GDP by 3 industry data, this ratio was 78% for the U.S. auto sector in 2018 implying 2 that value added – in the form of wages and profits – was equivalent to 1 just 22% of gross sales. The share of intermediate input costs across all sectors of the U.S. economy was much lower at 44% on average. 0 -1 These supply-chain multipliers will have increased the impact of the -2 auto demand slowdown on the wider economy. In addition, there will have been ‘induced’ effects on demand through lower wages and profits UK Italy USA India reducing household and corporate spending (this is not captured in the Brazil Spain China Switz. Korea Russia Turkey Poland France Mexico

Canada output multipliers quoted above). Taking these multipliers into account, S. Africa Australia Germany Indonesia it seems reasonable to conclude that the recent 4pp decline in global car sales growth (relative to the average rate seen over 2011 to 2017) could Source: Fitch Ratings, UN COMTRADE, National Sources, Haver Analytics have reduced world GDP by 0.2%. To put this into context, the reduction to Fitch’s 2019 global GDP growth forecast between the December 2018 and March 2019 Global Economic Outlook (GEO) was 0.3pp – one of the Output Multipliers in Sectors of EU28 Economy largest revisions in consecutive GEO reports.

Agriculture, Forestry & Fishing The Road Ahead Industrial Products The global auto market should see a broad stabilisation this year helped o/w Motor Vehicles by the policy cycle in China, but a strong rebound looks quite unlikely. Construction Fitch expects global car sales to grow by little more than half a per cent Wholesale and Retail Trade in 2019. U.S. and European sales likely to post modest falls this year and China sales will be broadly flat, with the global expansion primarily Information and Comm. Services reflecting growth in other emerging markets. Global sales growth Financial Services should rise to around 2% in 2020 as demand growth recovers towards Real Estate Sevices normalized rates of around 2% to 3% in China and 0.5% to 1% in Europe Professional Services and the U.S. However, growth is unlikely to return to 4%, even over the medium term. Lingering overcapacity concerns will also limit the extent Public Sector to which investment spending by auto companies can contribute to Arts, Entertainment & Recreation global demand. 0 0.5 1 1.5 2 2.5 China Increase in Total Output Following Unit Increase in The fall in car sales in China in 2018 partly reflected the full expiration of Final Demand in Sector earlier cuts to the rate of vehicle purchase tax (VPT) on new car sales. The Source: Fitch Ratings, Eurostat authorities cut VPT temporarily to 5% from 10% in October 2015 as a means of stimulating demand. The rate was increased to 7.5% in January 2017 and reverted to the original 10% in January 2018. The monthly Share of Intermediate Inputs in Gross Output - US pattern of car registrations shows a clear impact from these tax changes, which essentially served to bring forward demand for new cars (see https://www.fitchratings.com/site/re/10068134). This headwind All industries will not be repeated in 2019. Moreover, we expect renewed stimulus Agriculture, Forestry & Fishing measures to be announced this year. While the authorities denied Mining intense media speculation last November of another round of VPT Utilities cuts, there have been official pronouncements of intentions to support Construction Manufacturing the auto market in some way. Indeed, part of the recent weakness o/w Motor vehicles in sales has been attributed by market commentators to consumers Wholesale Trade anticipating tax cuts. This may have been compounded by delays by Retail Trade some manufacturers in passing on the recent cuts in national VAT rates, Transport & Logistics Information Services leading buyers to adopt a wait-and-see attitude in the hope that prices Finance and Real Estate will fall (see https://www.fitchratings.com/site/pr/10068444). Professional Services Educational, Health & Social The credit cycle has also been important for car sales in China as Arts, Entertainment evidenced by their close correlation with our measure of the credit Government impulse. The latter is based on the change in borrowing (our credit 0 20 40 60 80 measure is aggregate financing to the real economy excluding equity plus local government bonds) as a share of GDP. The credit impulse Intermediate Inputs as % of Gross Output, 2018 turned negative in early 2018 as the authorities’ squeeze on shadow Source: Fitch Ratings, BEA financing took effect and this coincided with reports of deteriorating

www.fitchratings.com | May 2019 6 credit availability of car finance, including slower growth in peer-to-peer China Car Sales and the Credit Impulse lending platforms. However, the credit impulse turned positive in 1Q19 following the more recent policy easing and this has seen several macro Credit Impulse (AFRE exc equity + LG bonds) indicators starting to show signs of stabilization. Car Sales y/y (RHS) Several factors point against a sharp rebound in activity. Inventories 25 100 rose rapidly relative to sales in late 2018, which will make output less 20 80 responsive to demand in the near term (see https://www.fitchratings. com/site/re/10071976). In addition, a number of structural changes 15 60 are likely to continue weighing on demand, including increased consumer concerns about environmental issues and related policy 10 40 responses, and the growth in used car transactions. Several cities have responded to growing concerns about air pollution and congestion in

5 20 (% yoy) recent years by imposing restrictions on registrations. These types of 0 0 restrictions could now see some temporary reversals if the government seeks to support sales in the near term, but they are likely to remain a -5 -20 feature over the medium term. Moreover, some of the recent weakness -10 -40 in sales reflects the early adoption of new (‘China 6’) fuel-emission (Change inGDP)(Change Borrowing,of % standards. While sales of electric cars are growing rapidly and incentives to trade in older, less fuel-efficient, vehicles could help new demand, 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 growing social concerns about the environment are likely to slow the Source: Fitch Ratings, CAAM, NBS, PBOC, Datastream rate of increase of car ownership. Recent policy changes have also made used car ownership more viable. Used car purchases transactions have grown rapidly in the past couple of years, weighing on new car sales. US New Car Sales and Vehicles per Capita The current low car-ownership ratio (120 vehicles per 1,000 people in 2015 according to OICA), strong growth in disposable income and New Sales (LHS) Stock of Vehicles Per 1000 People rising urbanization bode well for a sustained resumption in sales growth 20 900 over the medium term. But environmental issues, the growth in used car sales and higher household debt levels are likely to prevent sales 18 850 growth regaining the double digit rates seen over 2010 to 2017. Fitch’s 16 auto analysts see demand more or less flat this year before gradually 14 recovering to low-single-digit growth rates (translating to 500,000 to 1 800 million additional sales a year) over the medium term. 12 U.S. 10 750 While U.S. car sales marginally exceeded expectations in 2018 at 17.1 8 million, the broader picture has been one of remarkable stability in the

(Million Units) (Million 700 6 level of sales since early 2015. This may seem surprising in the face overall consumer spending and real household disposable income 4 650 '000per people)(Cars growth averaging over 2.5% a year since then. This partly reflects the 2 normalization of broader U.S. financial conditions as the Fed raised 0 600 interest rates. Growth in auto loans – which is closely correlated with 1976 1982 1988 1994 2000 2006 2012 2018E auto sales – was running at 8% to 10% over 2012 to 2015 but has now slowed to about 3%. Interest rates on auto loans have increased to over Source: Fitch Ratings, US Federal Highways Administration, BEA 6.5% from around 4.5% in 2014. A growing supply of late model off-lease vehicles may also have tempered the demand for new vehicles. Structural factors have also been weighing on car demand. Population Eurozone Big 4 - Monthly Car Sales growth has continued to slow through the second half of the current decade. More fundamentally, the U.S. auto market is at a mature stage. Germany France Italy Spain The stock of vehicles per capita (the motorization rate) started to 350 approach saturation levels in the early to mid-2000s at 800 to 850 cars per thousand people. This is high by global standards – for example, OICA 300 reports motorization rate of only 600 cars per 1,000 people for the EU15 (+ EFTA) and Japan in 2015 with only Italy and Australia showing rates 250 above 700 – and implies limited scope for further increases in the rate 200 over the medium term.

150 The U.S. motorization rate (using our own estimate of 847/1000 for 2018) has in fact shown quite a robust cyclical recovery since 2015, more (000's, S.A.) 100 in line with broader consumer trends. The vehicle stock has been growing by 1.5% a year since 2015, reflecting the fact that new sales have been 50 equivalent to 6.4% of the (lagged) stock whereas the scrappage rate has only been around 5% of the (lagged) stock (scrappage is the difference 0 between the change in the stock of vehicles and new sales). This is faster than U.S. population growth of 0.7% a year. However, given its elevated 2011 2012 2013 2014 2015 2016 2017 2018 2019 starting point we would expect the recent increase in the motorization Source: Fitch Ratings, Datastream rate to tail off as the wider U.S. economy slows. Our expectation is that

www.fitchratings.com | May 2019 7 EU15 Passenger Car Registrations by Fuel Type U.S. new car sales dip to 16.9 million in 2019 as a whole – in line with the latest three-month average – and remain at about 17 million over the EU 15 Total EU 15 Diesel next few years. This would imply a slower rate of increase in motorization (% yoy) if the scrappage rate remains steady. 15 Europe 10 Car sales in Europe recovered rapidly in 2014 and 2015 as the eurozone emerged from recession and sales growth remained strong throughout 5 2017. But sales slowed sharply last year – registrations were up by just 0 1.1% in the eurozone and declined by 0.6% in the EU15, the latter reflecting sharp falls in the UK. The interpretation of recent data is -5 complicated by distortions related to the introduction of new emissions -10 standards in Europe last autumn, which prompted a surge in registrations in August 2018 ahead of the new regulations and a subsequent -15 collapse. However, the broader picture that emerges is of an underlying -20 weakening, with sales levels in the first few months of 2019 little higher than 2017 average levels in most of the large economies. -25 Tight labor markets, solid household income growth, robust aggregate

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 consumer confidence readings and highly accommodative financial conditions make it hard to explain the extent of the slowdown in Source: Fitch Ratings, ACEA, Haver Analytics eurozone car demand from a purely macroeconomic perspective. One important sector specific shock is the fall-out from the diesel emissions scandal at VW and related environmental concerns about diesel. Alongside announcements of possible diesel bans in several EC Business Survey - Inventory Levels Auto Sector European cities and proposals to prohibit new diesel sales at some point, this has taken a heavy toll on demand for new diesel cars. Diesel sales 50 fell by nearly 20% in the EU15 last year, with the share of diesel in total sales falling to 37%, its lowest level since 2001. Over time, the impact 40 of environmental concerns on new car sales could be mitigated by the emergence of cleaner engine types, but it looks as if diesel-related 30 concerns are weighing on the overall European market. 20 The car market in western Europe has, like the U.S., also reached mature levels with high motorization rates. Our estimates suggest (based on an 10 assumption of steady scrappage rate from 2015) that the motorization rate increased quite sharply over 2016 to 2018 with the vehicle stock rising by 0 over 1.5% a year, compared with population growth of about 0.4%. Sales are expected to decline by 0.5% to 1% in 2019 in the four -10 largest eurozone economies combined. Moreover, surveys point to a sizeable pick-up in inventory levels (see chart below), which will further -20 dampen the recovery in output levels. This cautions against expecting (Balance: Reporting Excess Inventories) a sharp re-acceleration in overall eurozone industrial production in 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 the months ahead. Motor vehicles production represents over 11% of Source: Fitch Ratings, EC, Haver Analytics total manufacturing value-added for the big four eurozone economies combined (France, Germany, Italy and Spain). This inventory dynamic may well be playing out in Germany where the Germany Auto Production, Sales and Exports recovery in car production since December has severely lagged the rebound in domestic registrations. However, Germany’s auto sector is also (% yoy, Output Registrations in Germany Exports crucially exposed to global demand trends, as shown by the particularly 3m.m.a.) strong correlation between output and exports. One source of external 15 demand weakness for German cars has been the UK, where registrations 10 fell by nearly 7% in 2018. Brexit uncertainty is likely to have been a key factor here along with a regulatory squeeze on auto lending since 2017. 5 UK sales are expected to decline again this year by around 3%. 0 Other Markets -5 The larger emerging markets outside China saved global auto sales from a sizeable outright decline in 2018. Sales in Brazil, Russia and India picked up -10 from early 2017 as Brazil and Russia emerged from recession and grew by 9% in 2018. We expect a slowdown in the rate of growth in 2019 reflecting -15 recent weaker monthly outturns, but these three economies combined -20 are expected to generate an additional half a million units in sales. The forecast table at the end of this report details our sales projections for the -25 major markets. 2012 2013 2014 2015 2016 2017 2018 2019 Source: Fitch Ratings, Haver Analytics

www.fitchratings.com | May 2019 8 Downside Pressures and the Trade Threat UK Car Registrations and Consumer Credit The resumption of slightly positive growth in global auto sales in 2019 Consumer Credit (exc. Credit Cards) is consistent with our view that downward pressures on global GDP Car Registrations Y/Y (RHS) growth will abate this year, leaving 2020 global GDP growth the same as 6 30 in 2019 at 2.8%. This auto sector outlook would, nevertheless, imply only a sluggish improvement in global manufacturing indicators in the near term and a very lackluster recovery in world trade. Moreover, the threat 4 20 of new tariffs hitting the auto sector is a material downside risk and one that would have a sizeable impact on the world economy. 2 10 Three ‘live’ policy debates have the potential to culminate in a sharp increase in auto tariffs in a worse case outcome. Firstly, the U.S. 0 0 Commerce Department’s recent Section 232 report concluded that auto imports were a threat to U.S. national security. President Trump has (% yoy, 3m.m.a.) yoy, (% -2 -10 asked the U.S. Trade Representative to embark on negotiations over the next six months, leaving open the possibility of the eventual imposition -4 -20 of 20% to 25% tariffs on car imports from the EU and Japan. Secondly,

(Annual change in yoy credit growth, pp) the United States Mexico Canada Agreement has not yet been ratified by

2011 2012 2013 2014 2015 2016 2017 2018 2019 Congress and it is possible to envisage a scenario where President Trump threatens to withdraw from NAFTA altogether as a means of applying Source: Fitch Ratings, Datastream, SMMT, Bank of England leverage on Congress. Thirdly, a ‘no-deal’ Brexit would see an overnight increase in tariffs on auto trade between the UK and the remaining EU countries with loss of UK access to the single market severely affecting supply-chains. The recent escalation in U.S.-China trade tensions could Export Orientation also affect global auto trade, although U.S. auto imports (including parts) Whole Economy Cars from China are quite small at USD21 billion (2017) compared with USD62 100 billion and USD53 billion from the EU and Japan, respectively. 90 The global nature of auto production makes the sector particularly 80 vulnerable to an increase in tariffs. Trade openness measured by the 70 ratio of imports plus exports to output is typically much higher for the 60 auto sector than for the economy as a whole. This is also true on the 50 basis of a more sophisticated measure of export orientation published by the OECD in its Trade in Value Added (TiVA) database. This database 40 is constructed from global input output tables that fully articulate 30 international supply chain relationships and allow a decomposition of 20 gross export flows between countries into those used as intermediate 10 inputs in the destination country and those destined for final demand. 0 They also show the extent to which exports from a country reflect imported intermediate imports from upstream suppliers. This UK (Export (Export Demand as % Total Value Added) US

Italy granularity allows the OECD to isolate the domestic value-added (or GDP) Switz. Brazil Spain China Korea Japan Iundia Russia Turkey France Poland

Mexico component of exports by country and by sector. Canada S. Africa Germany Australia Indonesia As the chart shows the share of total value added in the auto sector that Source: Fitch Ratings, OECD TiVA is ultimately absorbed by foreign demand (exports) is much higher than for the economy as a whole across nearly all the Fitch 20 economies. In other words, external shocks (such as a tariff dispute) typically have Share of Intermediate Imports Re-Exported a bigger impact on the auto industry than on other sectors. Nowhere is the truly global nature of auto production illustrated more clearly than Whole Economy Cars the exports of BMW SUVs manufactured in U.S. plants to China or the 100 production of Japanese cars in the UK for export to the rest of Europe. 90 The same OECD database also shows how tariffs can have a particularly 80 disruptive impact on the auto sector through cross-border supply chain 70 linkages. The share of intermediate imports, which are then used as an 60 input for export production, is typically higher in the auto sector than 50 for the rest of the economy. This illustrates how a rise in tariffs on autos 40 and auto parts could cascade through the international supply chain 30 as auto components and semi-finished goods cross borders several 20 times before reaching their final destination, potentially suffering a tariff charge at each crossing. (% of IntermeditaeImports) 10 0 Fitch research published last year (see https://www.fitchratings. com/site/pr/10039304) showed that a global trade war scenario that UK US Italy India

Brazil involved the imposition of auto tariffs by the U.S. and retaliation from its Spain China Switz. Korea Japan Turkey Russia France Poland Mexico

Canada main trading partners would reduce global growth by 0.4pp, although S. Africa Australia Germany Indonesia this analysis also assumed a sharp ramp up in U.S.-China tariffs. Source: Fitch Ratings, OECD TiVA

www.fitchratings.com | May 2019 9 References

Eurostat: ‘Consolidated Supply, Use and Input Output Tables’ February 2019 St Louis Fed: ‘The Ties that Bind – the Auto Industry and the US Economy’ April 2019

Global Auto Sales Outlook Brazil + Eurozone India + Rest of World China US Big 4 UK Japan Russia World Level, Mn Units 2017 81.9 25.0 17.1 8.8 2.5 4.4 6.5 17.6 2018e 81.8 23.9 17.2 8.9 2.4 4.4 7.1 18.1 2019f 82.4 23.9 16.9 8.8 2.3 4.4 7.5 18.5 2020f 84.1 24.4 17.0 8.9 2.3 4.4 8.1 19.0

% Change 2017 2.2 2.4 -1.9 5.0 -5.7 5.9 9.9 2.6 2018e -0.1 -4.3 0.3 1.2 -6.8 0.1 9.1 2.5 2019f 0.7 0.2 -1.7 -0.7 -3.0 0.1 7.0 2.5 2020f 2.0 2.0 0.8 0.8 0.8 0.0 7.0 2.5

Change, Mn Units 2017 1.8 0.6 -0.3 0.4 -0.2 0.2 0.6 0.4 2018e -0.1 -1.1 0.0 0.1 -0.2 0.0 0.6 0.4 2019f 0.6 0.1 -0.3 -0.1 -0.1 0.0 0.5 0.4 2020f 1.7 0.5 0.1 0.1 0.0 0.0 0.5 0.5

Source : Fitch Ratings, National and Industry Sources, OICA

www.fitchratings.com | May 2019 10 Contacts

Economics

Brian Coulton Chief Economist Pawel Borowski Tel: +44 20 3530 1140 Tel: +44 20 3530 1861 [email protected] [email protected]

www.fitchratings.com | May 2019 11 Disclaimer

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