Harsher global economic conditions will impede the recovery of auto sales and production over the next two years. S&P Global Ratings believes it will take until late 2024 for global sales to even approach 2019 levels of nearly 90 million. The same holds true for production.

For 2022, we continue to expect flat growth for global light-vehicle sales at best and moderate production growth of 3%-4%. We have, however, adjusted our regional sales forecasts considerably to reflect worsening conditions in the U.S. and Europe, counterbalanced by a more resilient Chinese market despite disruption from its zero-COVID stance.

Suppliers are more likely to face credit impact than automakers, in our view, due to adverse economic and geopolitical conditions extending low visibility on production plans, persistent supply-side shortages, and higher costs. Original equipment manufacturers (OEMs) are shielded by higher pricing power, larger headroom in credit metrics due to healthy balance sheets, and comfortable liquidity buffers. That said, we see pressure on margins and cash flow generation ratcheting up in the next two years in Europe and the U.S. for both OEMs and suppliers.

Despite a more anemic global auto market, we expect electric vehicles (EVs) will maintain strong momentum in picking up market share and maintain our forecast of about 20% global penetration by 2025. Momentum in the three main global markets could differ, though.

Table 1

Divergence In Regional Sales Performance

In the U.S. and Europe, declining economic conditions will slow recovery compared with our prior expectations.  In the U.S., we anticipate light-vehicle sales will contract by 4%-6% in 2022, against our March expectation of up to 2% growth, with volumes hitting lows not seen since 2013 (see chart 1). Our updated forecasts take into consideration softer demand due to mild recessionary conditions in the U.S. in 2023 (including modest GDP growth of 0.2%), continued supply disruptions, and a larger spike in inflation, which has led to the Federal Reserve planning interest rate hikes into early 2023 (see "Economic Outlook U.S. Q4 2022: Teeter Totter," published Sept. 26, 2022, on RatingsDirect).

We forecast an even sharper contraction in European light-vehicle sales of about 10% in 2022, with volumes dropping to the lowest point in over two decades, largely reflecting the direct and indirect impact of the Russia-Ukraine conflict. In 2023, we expect the European economy will slow abruptly, with GDP growth dropping to 0.3% from 1.8%, and we cannot exclude the possibility of a full-blown recession (see "Europe Braces For A Bleak Winter," published Aug. 29, 2022). Consumer confidence has also plummeted after a dramatic increase in the cost of living, particularly from higher food and energy prices, while the European Central Bank has front-loaded interest rate hikes to fight record-high inflation.

Chart 1

In China, a rebound in consumption should support growth in 2022, though COVID-linked policies add uncertainty over the longer term.  The Chinese government has cut the purchase tax in half for internal combustion engine vehicles priced at or below Chinese renminbi (RMB) 300,000 ($40,000-$45,000) with engine displacement of up to 2.0 liters for June through December of this year. This has resulted in a strong rebound in the country's light-vehicle consumption of 20%-30% year on year in the past three months. As such, we increased our March forecast for China's light-vehicle sales growth to 4%-6% for 2022 from 1%-3%. With demand pulled forward to the second half of this year and our expectation that economic recovery will remain muted through first-quarter 2023, we foresee sales growth decelerating to 0%-2% in 2023. Moreover, we believe China's zero-COVID policy and the potential withdrawal of related government stimulus could constrain sales growth next year. That said, we believe subsidies for pandemic-related disruptions are likely to continue. For 2024, we anticipate slightly higher growth, on improving consumer confidence amid economic recovery.

Additional downside to current forecasts could result from weakening labor markets from 2023 and more aggressive central bank monetary policies to combat inflation.  We note that labor markets are very tight in the U.S. and Europe, and weakening would ultimately further dent pent-up demand. We see downside in 2023 as more likely in the U.S. than Europe though, since our forecasts for the latter are at an all-time low, with limited prospects of recovery to pre-pandemic sales volumes even by 2025. For China, we view changes in the government's approach to managing the pandemic, as well as the timing and magnitude of stimulus efforts, as the main factors that could result in deviation from our sales forecasts.

Further Delays To Production Recovery

Low visibility on supply-chain improvements and pockets of uncertain demand will see light-vehicle production struggle to reach pre-pandemic levels in 2024, in our view.  Disruption to the auto sector's semiconductor supply chain persisted in third-quarter 2022 amid increasing uncertainty on geopolitical disruptions. There is a high likelihood of extended supply chain-related bottlenecks in 2023, though they would likely be less severe than those observed over the past two years, which involved batteries and certain electronic components in addition to semiconductor chips. Pressure to aggressively rebuild inventory will also be less of a driver for production, given uncertain demand lingering in at least two major markets (U.S. and Europe). We forecast light-vehicle production growth of 3%-4% in 2022 (unchanged), 6%-8% in 2023 (down from 8%-10% previously), and 2%-4% in 2024 (sharply down from our previous forecast of 7%-9%), putting volumes still below the pre-pandemic level of about 90 million two years from now.

Additional downside to our forecasts could materialize in the case of heightened geopolitical risks linked to the Russia-Ukraine war and tensions building around Taiwan and North Korea.   In Europe, difficulty quickly replacing Russian gas is putting auto production in the region at risk (see "Scenario Analysis: Energy Rationing Could Hit The Brakes On European Auto Production," published Sept. 30, 2022). Though a few automakers may be able to secure alternate supply, this will not be feasible for many auto suppliers. Automakers and suppliers around the world may need to replace some providers in case of supply deficits and high logistic costs.

Short-Term Credit Implications

U.S. and European OEMs and suppliers will likely see increasing pressure on margins and cash flows over the next two years.  As global inventories gradually recover, automakers face the challenge of avoiding oversupply to protect pricing power, which has more than offset the impact of lower volumes on revenue in 2021 and 2022 so far. In the U.S. and Europe, marginally higher production volumes in 2023 and higher nominal pricing may not fully offset high inflation. Asia-Pacific companies could fare better though, given lower inflation.

For our North American issuers, we do not anticipate substantial downgrades in 2023, though the negative outlook bias will intensify, since many ratings are already below pre-pandemic levels.  We expect margin pressure will rise in the region in 2023 because of shrinking demand for the highest-margin vehicles (SUVs and light trucks), limiting automakers' pricing power.

A key rating assumption is that the industry will exercise discipline while rebuilding capacity toward its revised inventory targets by 2023, which will be roughly 30% below pre-pandemic levels. This will ensure reduced pressure on automakers to raise incentives and lower price, hence protecting their margins somewhat, even if consumer demand weakens over the next 18 months. We do not assume any shift away from trucks to sedans, given consumer preferences and industry capacity constraints for passenger cars. Consumers will likely downsize toward entry-level products within the light-truck segments.

Additionally, we assume metal prices (which comprise over 50% of the cost of goods sold for auto companies) will remain high relative to historical levels. For some companies, this will erode liquidity and heighten downgrade risks. Despite lower fixed-cost absorption, most large and mid-tier companies have sufficient liquidity to weather a mild recession, or a scenario where U.S. sales in 2023 plateau at 2022 levels before making a slow recovery in 2024. However, weaker cash flow due to lower fixed-cost absorption could affect several mid-tier suppliers, a few lower-rated suppliers, and discretionary aftermarket suppliers that are already reflecting distress in our 'B-' or 'CCC+' rating categories.

In Europe, most automakers have rating headroom to absorb the impact of a temporary economic slowdown.  Increasing fiscal support in response to spiking energy prices could somewhat offset the softer auto demand in Europe. However, persisting inflationa and unprecedented high pricing for new and second-hand vehicles in Europe mean that the room to absorb structurally higher costs through pricing is reducing. We thus expect margins and cash flows at OEMS will be squeezed in the next two years. Rating pressure might be more acute at suppliers, due to their limited visibility on production patterns and difficulty fully passing on costs to automakers, further exacerbated in some cases by low flexibility in research and development and capital expenditure spending, as well as the need to keep inventory high to mitigate supply disruptions for clients. Repositioning product portfolios to navigate the energy transition will further encumber some rated suppliers.

In Asia-Pacific, we expect the credit strength of most rated auto companies to remain stable over 2023.  Profit margins of carmakers and suppliers in the region took a hit in 2022, on the back of the ongoing chip shortage, COVID-related production suspensions, and elevated raw material and logistics costs. Margin pressure is likely to ease next year, thanks to slight volume growth, fewer pandemic-related disruptions, softer commodity prices (mainly steel and aluminum), as well as continued internal restructuring for some producers. Uncertainty on the near-term evolution of battery cost remains high, with the price of some raw materials like cobalt declining, while lithium is at an all-time high. Still, we believe most rated players will maintain sufficient financial headroom, mainly thanks to healthy balance sheets. That said, traditional carmakers that are selling more EVs could face greater difficulties bringing margins back to pre-pandemic levels given the still-small sales volume. While electrification could compress margins and cash flow for OEMs in the short term, the ability to upgrade the EV product portfolio and ramp up sales while securing battery supply will be increasingly important for their competitive position over the medium term.

Electrification Continues To Gain Ground

We see strong momentum for EV penetration, despite the general auto market's weakness, given its role in the energy transition.  We continue to forecast EV penetration increasing into 2025, although we see a possibility of slower growth in 2023 and 2024, especially in markets with deteriorating economic conditions. According to figures from the database EV-Volumes.com, in the first eight months of 2022, passenger EV sales (battery electric vehicles and plug-in hybrid electric vehicles) increased 64% compared with the same period in 2021 in the 15 most relevant global markets, while total passenger car sales growth contracted 4.6%. This momentum also explains the persistent rise in lithium prices, a key component in EV batteries.

In Europe (Europe 10) EV sales expanded 6.0% in the first eight months of 2022 compared with the same period in 2021 versus a 12.3% decline for all passenger cars, bringing the EV share to 21.5% of the light-vehicle fleet.   Compared to last year, growth moderated substantially, and it is unclear at this stage whether the slowdown is demand driven or reflects the semiconductor shortage--likely a combination of the two. We assume EV growth could be slower in 2023 and 2024 than in other regions, due to high energy prices and rising interest rates, but we don't expect this will reverse the trend of increasing penetration.

Electrification is progressing rapidly in China, with sales of electric passenger vehicles up 122% in the first eight months of this year.   We expect penetration to reach 25% in 2022 in China, up from 14% last year. Broadening product offerings, increasing customer acceptance, and improving infrastructure are likely to cushion the potential phase-out of government subsidies and continue to support about 15%-25% growth in EV sales over the next two years. EV penetration could rise toward 30% next year and 35%-40% in 2024-2025.

In the U.S., the EV market share exceeded 6% in the first nine months of 2022, up from about 4% for the same period in 2021.  Given strong performance recently, we now expect the share of EVs to be over 7% for 2022. The faster-than-expected shift in consumer preference toward EVs has been due to attractive new models with improved battery efficiency and software capabilities, higher gas prices, and tax incentives. Based on significant launches in 2022-2025 with extended battery range at competitive prices and positive consumer sentiment so far, we forecast EVs' market share will exceed 18% by 2025. The Inflation Reduction Act (IRA), which takes effect January 2023, will likely spur EV demand and support some decline in prices through 2025, though profit pressure will intensify for the industry due to the rising cost of some battery components. Under the IRA, General Motors and Tesla EV vehicles will no longer be subject to the 200,000-vehicle sales cap, which blocked them from qualifying for federal tax credits. Several automakers--including Tesla, General Motors, and Ford--could qualify for three large sources of subsidies: tax credits to EV buyers (up to $7,500 per vehicle), subsidies to EV battery cell producers in the U.S. ($35 per kilowatt-hour), and subsidies to U.S. producers of battery modules and packs ($10 per kilowatt-hour). Foreign automakers are likely to find it harder to qualify for these subsidies, since they may need to adjust their production plan specifically to the final assembly provisions in the IRA, some of which need further clarifications.

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Related Research

• Scenario Analysis: Energy Rationing Could Hit The Brakes On European Auto Production, Sept. 30, 2022
• Economic Outlook U.S. Q4 2022: Teeter Totter, Sept. 26, 2022
• Credit FAQ: A Look At Who's Jostling For Position In Electric Vehicle Markets, Sept. 7, 2022
• Europe Braces For A Bleak Winter, Aug. 29, 2022
• European Corporate Credit Mid-Year Outlook 2022: Autos, July 14, 2022
• North American Corporate Credit Mid-Year Outlook 2022: Autos, July 14, 2022
• Battery Suppliers, Automakers To Take Charge As Price Rise, May 18, 2022
• Global Auto Sales Forecasts: Russia Ukraine Conflict Imperils Recovery, March 22, 2022