North American auto sales are on track to post their second best year on record in 2001, but this outcome masks the extremely challenging environment faced by the industry, say TD economists in a report released today. The report, entitled North American Auto Outlook: Still on a Rocky Road, includes forecasts of auto production and sales for Canada, the United States and Mexico out to 2003. “While the extension of zero-per-cent financing in the United States until January 2002 and the introduction of that incentive program in Canada are currently providing support to vehicle sales, the impact of the price initiatives will wane over time,” says Craig Alexander, senior economist at TD Bank Financial Group. “It is unlikely that the incentives have created significant new demand for vehicles, implying that current sales are largely stealing from those that would have occurred in the future. All told, the recent remarkable strength in purchases is actually signaling weaker sales in the first half of next year, which will restrain a recovery in the auto sector in 2002,” he adds. North American auto sales are on track to drop by 1.3 per cent in 2001 and a further 7.0 per cent in 2002, implying a total decline of roughly 8 per cent during the current economic downturn. This is worse than the last auto retrenchment in 1995, when sales fell by almost 5 per cent, but falls far short of the 1990-91 recession, when sales dropped by almost 20 per cent between 1988 and 1991. “Sales in Canada are expected to hold up better than those in the United States,” remarks Alexander. U.S. light vehicle purchases are expected to drop by 1.7 per cent this year and 7.9 per cent next year. This is a much bigger decline than the 0.2-per-cent and 3.7-per-cent contractions anticipated in Canada, which will see Canadian unit sales fall to 1.49 million in 2002 from 1.55 million in 2000. “Although North American auto purchases will rise in the second half of 2002 and throughout 2003, the recent strength in sales suggests there will be little pent-up demand for new vehicles when an economic recovery takes hold next year,” notes Alexander. Production suffers deeper contraction this year, but milder one next year North American auto production is expected to drop by 10.3 per cent this year, far exceeding the retreat in sales. Given that this partly reflects an inventory adjustment, the contraction in output next year is likely to be more modest, with an expected decrease of about 1 per cent, to 15.3 million units. Canada’s auto production is being particularly hard hit by the weak economic environment. After a 2.6-per-cent decline in 2000, Canadian light vehicle assembly is on track to drop by 13.7 per cent this year and is expected to fall by 1.9 per cent in 2002. While the deep 11-per-cent contraction in North American auto production expected during the current economic downturn is reminiscent of the retrenchment experienced in the 1990-91 recession, the almost 18-per-cent drop in Canadian production is far more severe this time around. The smaller decline in production that Canada experienced during the last recession partly reflected the impact of new plant expansion by foreign producers in the early 1990’s. Looking beyond the near-term outlook, U.S. and Canadian domestic auto producers face some significant medium-term challenges. The leading challenge for domestic producers is to regain lost market share,” observes Alexander. For the first ten months of this year, imports accounted for about 21 per cent of total light vehicle sales in Canada, compared with just 10 per cent in 1996. In the United States, imports have held an 18 per cent share so far in 2001, up from just 11 per cent five years ago. “Import penetration becomes an even bigger issue if viewed through the traditional lens of the market shares of the Big Three (General Motors, Ford, DaimlerChrysler) vis–vis all other auto manufacturers. Sales by the Big Three have accounted for roughly two-thirds of the combined Canadian and U.S. market this year, down from a three-quarter share in 1995,” says Alexander. The auto industry is also struggling with a fiercely competitive marketplace, which has fueled an incentive war that has crushed profit margins. “While consumers have benefited from generous incentives, those same measures have contributed to the financial losses recorded by the industry,” remarks Alexander. The auto sector has also been affected by problems at border crossings. In the wake of the September 11th terrorist attacks, there have been delays in shipments within North America and disruptions to just-in-time inventory systems. Although the delays at the border have already subsided and should continue to do so in the coming months, the industry needs assurances that free access will be maintained. “It is no exaggeration to say that the open border to the U.S. is the lifeline of the Canadian and Mexican auto industries,” says Alexander.