China has been slashing its electric car subsidies. That could backfire

Hong Kong(CNN Business) China wants to boost its adoption of electric vehicles. So far, that hasn't been easy.

Data released this week suggests that the Chinese market for new energy vehicles could shrink this year, according to an industry group. The China Association of Automobile Manufacturers said Monday that the sales of electric, hybrid and fuel cell cars plunged by over 45% in October, marking four straight months of declines in the sector.

"Because of the insufficient demand of the domestic market, the pressure for automakers to upgrade their technology to the national standard, and the major subsidy cuts for new energy vehicles, the recovery of production and sales is still limited," said Chen Shihua, assistant secretary general of the group.

"Based on the current developing trend, we may see negative growth for new energy vehicles this year."

The findings underscore the delicate spot that Beijing is in. China wants new energy vehicles to make up a fifth of its auto sales by 2025, and the government has outlined a goal of reaching 7 million in annual sales for those vehicles by that year. To that end, it has implemented a range of government subsidies and tax incentives for the production and purchase of electric cars, which has helped the industry grow.

But in recent months, authorities have had to balance that objective with another goal: weeding out an overcrowded field of automakers.

As of March, 486 new energy vehicle manufacturers were registered in China, according to the National Monitoring Platform for New Energy Vehicles, a group that tracks the sector. Several of them have raised billions of dollars in funding over the last few years, raising the specter of an industry bubble.

That has led the government to slash incentives dramatically. In March, it reduced subsidies for new energy vehicles, saying it wanted "to promote the survival of the fittest," according to Xinhua, China's official state news agency.

The cuts have exacerbated a sales slump in the world's biggest auto market, which has also been hit by a broader economic slowdown. In October, total car sales fell 4% compared to the same time last year, according to CAAM, the auto industry group.

Several prominent players in new energy vehicles are now suffering — and blaming it on the drop-off in subsidies.

Last month, BYD (BYDDF), one of China's top electric vehicle makers, reported an 89% plunge in net profit for the third quarter, saying that sales had failed to meet expectations partly due to "the considerable reduction" in subsidies.

In September, NIO, the Shanghai-based unicorn once known as China's answer to Tesla, also blamed a sales dip in the most recent quarter on lower incentives.

"People currently associate EVs with some form of government welfare being handed out," said Tu Le, founder of Beijing-based consulting firm Sino Auto Insights.

He said the latest sales data marked "a huge hiccup" for Beijing, "but it doesn't dissuade what their long-term plans are."

While Beijing needs growth to meet its objective, Le predicts that much of that will come from international automakers that have yet to blitz the market, not current major players that have focused on domestic sales in China.

Several foreign companies have recently announced plans to ramp up their electric car offerings in the country, such as Tesla (TSLA) and Volkswagen (VLKAF). Both recently started trial production at new factories in Shanghai, and others are expected to follow.

These traditional automakers benefit from having an established brand, while many EV startups in China are still new to the market and "need further incentive for the Chinese consumer to purchase [from them]," said Le.

Players like Volkswagen are also expected to have a more affordable lineup than most homegrown startups, which tend to focus on premium vehicles, he added.

"That's where I think that difference is going to come in," he said. "The bulk of the sales are going to be driven by the foreign [automakers] at these different price points."

The industry could be challenged even further. China is in the process of deliberating more subsidy cuts, Bloomberg reported Friday, citing people familiar with the matter. The finance ministry did not immediately respond to a request for comment from CNN Business on Tuesday.

"This is really kind of an extreme case of testing the Chinese government's flexibility on what they need to do, or what they should back off on, in order to keep the momentum moving forward," said Le.

"I think they see reinforcements coming in, through foreign automakers ... I think that will boost sales."