China is the world’s largest investor in new energy vehicles (NEVs). For the past decade, the government has put its might behind developing electric cars, spending billions on consumer-facing subsidies to lower the upfront costs of these vehicles.

These subsidies made China the largest electric vehicle market in the world, growing 450% in the six years ending in 2015. Pure battery-powered cars seemed to be winning the race. With 75% of all NEV sales in the country between 2009 and 2015, they catapulted ahead of alternatives like plug-in hybrids (vehicles that use both electric and gas power).

This year, however, Beijing changed its tack. The government dramatically scaled back subsidies, forcing automakers to boost innovation and reduce reliance on government incentives.

The move immediately caused an industry-wide speed wobble. In July, the first full month since the cuts were imposed, sales of NEVs fell for the first time in two years. This was followed a month later by a steeper 16% decrease year-on-year.

In July, marking a notable shift towards fuel-efficient technologies, a government vice minister stated that China was setting a new agenda to adopt a more diversified technology approach for NEV development in the future. What has the central government done to bolster the nascent industry and why it is changing its policy?

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Shift toward hybrids

Hybrid vehicles have never really taken off in China, despite worldwide support. These vehicles accounted for just 10% of the 1.5 million passenger vehicles that Toyota sold in the country last year.

Hybrids typically have not benefited from the government’s preferential electric vehicle subsidies, falling between the cracks of government support and public favor.

This year, the situation quietly began to change. The first major shift came from China’s dual-credit policy, the country’s complex point-based system requiring automakers to produce a certain number of NEVs. The Chinese government defines three types of vehicles as NEVs: pure electric cars, plug-in hybrids, and hydrogen fuel cell vehicles. Traditional hybrids are categorized as conventional internal combustion engine (ICE) powered vehicles.

For example, in one case, an automaker would be required to produce 20,000 electric cars for every 1 million traditional gasoline-powered vehicles in order to be awarded credits as part of China’s emissions-reduction policies.

This policy has now shifted to increase focus on hybrid vehicles, a dramatic move from Beijing’s initial goals. Under a modified version of the policy released by the Ministry of Industry and Information Technology (MIIT) in July, the target could be slashed by as much as 70% to less than 6,000 electric vehicles if one million vehicles produced by automakers are all hybrids.

Going even further, hybrids will be reclassified as “low-fuel-consumption passenger vehicles,” granting them more preferential treatment in the future, and differentiating them from both internal combustion engine cars and electric vehicles. Beijing aims to issue the updated regulation by year’s end after soliciting feedback from industry experts and the public.

What is compelling the government to make such a major shift? Well, China initially laid out an ambitious timeline to completely ban national production and sales of ICE vehicles, said Xin Guobin, deputy head of the MIIT, at a trade conference in late 2017. However, sales of NEVs have slowed substantially since last year, hit by the flagging economy as well as public concern over range problems and car safety.

Also, when compared with the volume of 240 million ICE vehicles nationwide last year, the 2.6 million NEVs currently on the road barely register, which makes fuel-efficient development more urgent.

More worryingly, Chinese OEMs took advantage of the policy, producing a low number of electric cars to achieve credits even as they sold gas-guzzlers without scruples. China’s average fuel consumption surpassed 7 liters per 100 kilometers in 2017, according to figures from the Innovation Center for Energy and Transportation (iCET). The think tank warned that if the situation continues unchanged, Beijing may not be able to meet their goal of 5 liters per 100 kilometers by 2020.

Subsidy cuts for NEVs

China’s subsidy policies go back as far as 2009. The country had been late to produce passenger cars, lagging behind the US, Japan, and Germany. With the development of electric vehicles, the government hoped to change this trend.

During that year, China’s state planner, the National Development and Reform Commission (NDRC), partnered with three other departments to kick off an ambitious financing plan paving the way for China to become a leader in NEV development and adoption. In 13 municipalities—including Beijing, Shanghai, southwestern Chongqing and northeastern Changchun—the government body laid the groundwork to roll out 1,000 electric vehicles for public services (including buses, taxis, and postal services) over three years.

Over the next several years, consumers benefited from generous government subsidies. A car buyer could save as much as RMB 60,000 (roughly $8,500) when purchasing a pure electric car. In 2015, the savings amounted to nearly a third of the price of a medium-level vehicle with a range of about 240 kilometers.

However, the government knew that they couldn’t support subsidies indefinitely. In late 2015, these grants were scaled back for the first time by 10%. This was followed by a further cut in 2016, which slashed the subsidy for a high-performance electric car by nearly 20% to RMB 44,000. According to a 2016 subsidy-reduction plan released by the Ministry of Finance (MoF), China planned another 40% cut by 2020.

The other shoe finally dropped in March of this year. The MoF announced its intention to completely do away with subsidies for EVs with a range of below 250 kilometers, starting in June. The incentive for high-performance electric cars was also slashed by 50% to just RMB 25,000. What’s more, the central government revealed plans to phase out financial support completely after 2020.

The upshot is that electric cars have become substantially more expensive for either the buyer or the manufacturer, depending on who absorbs the additional cost. For bigger manufacturers, dealing with a post-subsidy world could prove to be easier than for China’s numerous EV startups.

But there was a method to Beijing’s madness. After years of government subsidies, China has become home to scores of electric vehicle makers; as of this May, nearly 500 companies had registered as such. Yet most of them haven’t delivered a single vehicle to consumers, and experts believe the majority of these companies will go under as part of an accelerated process of Darwinian competition.

The situation is precarious even for the handful of startups that have managed to deliver vehicles. Once-promising EV stars, such as Nio and Xpeng Motors, have been beset either by customer complaints or a series of car fires. In fact, there has been widespread fear that the ballooning market may be at a risk of bursting, as manufacturers have become overreliant on the government, which holds them back from developing better vehicles on their own.

Amid flagging sales and waning consumer confidence, the government has realized that more time is needed for automakers to deal with key issues around driving range and battery safety. If China is ever to lead the world’s electric vehicle market, it could be a long and bumpy road.

Jill Shen

Jill Shen is Shanghai-based technology reporter. She covers Chinese mobility, autonomous vehicles, and electric cars. Connect with her via e-mail: jill.shen@technode.com or Twitter: @yushan_shen

Chris Udemans

Christopher Udemans is TechNode's former Shanghai-based data and graphics reporter. He covered Chinese artificial intelligence, mobility, cleantech, and cybersecurity.