Hamish McRae: China and India in the rear-view mirror as troubles intensify for Western car makers

The motor trade is an extraordinary business. On the one hand, in terms of both scale and sustained growth in demand, it is arguably the most successful in the world. On the other, it is one in which it is at best very hard to make much money and at worst, one in which you lose your shirt. Last week, MG Rover became a sad example of the latter.

There is nothing really wrong with the cars. The range was ageing and quality a bit uneven, but in the JD Power owner-satisfaction ratings the Rover 75 came out very well. The trouble is that to produce a decent car is not enough. The competition is so fierce, you have either to make outstanding cars or be able to make decent cars very cheaply.

Rover was billed as being a volume producer but it accounted for only around one-quarter of 1 per cent of world car production. You can play the blame game and many people will. But if we were honest with ourselves, we all knew that whatever the company did, it was only a matter of time before it collapsed.

But Rover's demise is a small sign of a global industry under huge pressure. Last week, disturbing news emerged about the two largest US manufacturers, General Motors and Ford, and the US-German DaimlerChrysler. They all have the advantages of scale, and the global motor business has just had a boom year. But all three are in a mess.

Both GM and Ford report results next week. Ahead of these, GM shares have hit a 12-year low on news that it will hand over some documents to US regulators examining the accounts of a former subsidiary. The background to this is that the group is beset by high healthcare and pension costs as well as poor profitability, and its credit rating has recently been downgraded.

Ford is suffering from similar pressures and the rating agencies have warned in the past few days that they may downgrade its debt too. The worries concern profitability, the switch of US buyers away from sports utility vehicles (SUVs) and international competition.

As for DaimlerChrysler, the possibility is not so much for a downgrading of debt but for a break-up bid. The Chrysler part is now in not-too-bad shape, but back in Germany, its Mercedes business is in serious trouble over its quality.

Last week the company revealed that it had received several approaches from venture capital firms which wanted to break it up. It rebuffed them, but it is a sign of the pressure the group is under that it might be worth more if taken apart than it is together.

Indeed, looking around the world, the only big manufacturer in the developed countries that is completely secure is Toyota. It is not only the most advanced in developing eco-friendly hybrids, but consistently tops the owner-satisfaction tables (thanks to its Lexus luxury brand).

However, outside the developed world, and most particularly in China and India, there is everything to play for.

Some numbers to put this in perspective - global ones first. In the left-hand graph, you can see how annual car production has increased from some 18 million in the mid-1960s to 41 million in 2002; it rose to 42 million in 2003, and provisional figures put it at 44 million last year. Meanwhile, the car fleet - the total number of cars on the road - is now more than 500 million, rising inexorably year by year.

The other graph shows the national breakdown last year, taking total vehicle production rather than just cars - the world tally was 64 million. (Taking vehicles overall instead of just cars makes a big difference to the ranking of the US, which now makes fewer regular cars than Japan; in the States, the most popular vehicle is not a car at all but a Ford truck.) China is the new kid on the block, passing France to become number four. The UK just squeaks into the top 10 at 1.8 million, while (not shown) India is snapping at our heels with 1.5 million and may well pass us this year.

Indeed, the big story in global growth is what has been happening in China and India. In 2000, China built just over two million vehicles and India 800,000. So they have doubled production in four years. They won't necessarily double again in the next four, but such a solid growth trend has been established in both countries that it is quite likely that within a decade China and India will have passed Germany to become number three and number four in the world league.

Behind China and India come other low-cost countries, including the new members of the EU in Central and Eastern Europe, and Mexico and Brazil in Latin America. All offer much lower wage costs.

The question then is, by how much will the motor industry in the US and Western Europe have to shrink? The US has been kept going by the profitability of the huge SUVs and the trucks, but both are threatened by high fuel prices and are going out of fashion. In Europe at the moment there is around 30 per cent overcapacity. Saab in Sweden is particularly vulnerable and Fiat in Italy faces radical surgery. The subsidiaries of GM and Ford in Germany also are likely to be slimmed down, as is VW.

At best, the US and Western Europe face a slow, inexorable squeeze, with a plant closing or a labour force being downsized every few months. At worst, there will be some sort of sudden, wrenching change, maybe brought about by the financial pressure on the US giants. The financial markets are seriously worried and those worries themselves undermine the finances of the companies concerned by increasing their cost of funds.

Here in Britain the big story is Rover. Actually, by Western European standards, the UK is quite well placed, with a wider variety of manufacturers building cars here than anywhere else in Europe. But in the global picture, the demise of Rover is sadly not very important. I suppose one could say that it is better to get the pain over swiftly and develop other employment opportunities in the region.

For the rest of Western Europe and much of North America, however, the pain will go on and on as plants close and jobs disappear. The only issue is how swiftly this happens, and the financial weakness of GM and Ford suggests things may now move rather fast.

Is China planning a currency shake-up?

This weekend the G7 finance ministers and central bank governors are having their half-yearly meeting in Washington, and the more formal meetings of the IMF and World Bank are also taking place. No fireworks are expected at the G7, but it takes place against very twitchy markets.

US shares have had a really bad few days and late on Friday were pulling down the London market too. There has been talk that the Dow index has fallen through one of its support levels, which if you believe that sort of thing, is bad news for shares for some months at least. There are also real worries in the bond markets about the potential downgrading of Ford debt (as noted above). The company is the second-largest issuer of corporate bonds.

There are only two bits of potential good news in the wings. One is a fall in the oil price. It has come down in the past fewdays and the International Energy Agency in Paris has suggested there will be further falls. This would be very helpful, taking pressure off US inflation and slowing the rise in its interest rates.

The other is less obvious: some move towards a revaluation of the Chinese yuan. The Chinese were invited to the G7 meeting but declined. Why?

The conventional explanation is that they don't want to be bullied about a revaluation of their currency and they are showing their irritation at earlier pressure by staying away.

But there is a conspiracy theory, well articulated by research group Capital Economics. This is that "China is about to change its currency regime but does not want to give the appearance of doing so, especially to the US".

Apparently, Prime Minister Wen Jiabao said after the National People's Congress in March that any change would come unexpectedly.

It would certainly fit with the capacity that all monetary authorities have for surprising the markets, though arguably there is less domestic need now for a revaluation than there was last year, as the country's economy is slowing already.

But there is a growing groundswell of protectionism in the US Congress and the Chinese authorities may feel that it would be prudent to take any steps they comfortably can to head this off. I don't know how Congress would respond, but a revaluation would certainly be welcomed by the markets, which right now need all the help they can get.