The growth engine for the world’s car industry has been thrown into reverse, with China recording the first annual slump in auto sales in more than two decades—though progress in trade talks with the U.S. and planned government incentives offer a ray of optimism.

Sales in the world’s biggest market fell 6 percent to 22.7 million units last year, the China Passenger Car Association said Wednesday. The trade war and a slump in Chinese stocks have put off buyers in an industry where warning lights are already flashing worldwide.

Automotive demand has been particularly hard hit by the trade tension that’s strained China’s $12.2 trillion economy—prompting the government to prepare stimulus measures to revive sales. Chinese automakers rose Wednesday on the announcement, while Germany’s Daimler AG, BMW AG and Volkswagen AG also gained amid progress in trade talks between China and the U.S.

Manufacturers that spent billions of dollars adding plants and production lines in China in the past decades are uncertain if and when growth will return. A continued aggressive expansion would risk saddling the companies with excessive capacity, while a too cautious approach would hurt their ability to take advantage of a rebound.

“Pressure on automakers is mounting,” said Cui Dongshu, secretary general of the PCA. “Declining car sales may speed up the process of squeezing out the incompetent players and we may see some of them exit the market next year.”

What’s happening in China is a reflection of the situation worldwide, with rising prices, political upheaval, dislike for diesel and new services such as car-sharing eating into auto demand in markets such as the U.K. and the U.S. With the last great hope—China—also faltering, the global auto industry may already be in recession, according to RBC Capital Markets.

Sales volumes will probably fall 7 percent this year in China as the car market enters an unprecedented multi-quarter decline, Goldman Sachs Group Inc. predicted this week. Volumes may start to recover in 2020, rising 3 percent, the company forecasts.

The China Association of Automobile Manufacturers expects the market to be unchanged in 2019. While demand for gasoline cars wanes, rising sales of electric cars will probably help the overall market to avoid another slump, the association said in its outlook issued Dec. 13.

“Demand for vehicles is still there, yet it may take about three years for the market to pick up pace,” the CAAM said. “The overall uncertainties that may undermine car purchases include volatility in economic development and China’s trade relations with the U.S.”

The PCA, which tracks the auto retail market, has said it expects sales to rise 1.2 percent in 2019. Car-ownership restrictions in major cities including Beijing have been weighing on demand, and a possible relaxation of such curbs may help boost sales over the coming year, the association said Wednesday.

In December, retail sales of sedans, multipurpose vehicles and sport utility vehicles plummeted 19 percent—the seventh straight monthly drop.

Expansion Plans

Manufacturers now need to decide whether to go through with costly expansion and modification plans. Ford Motor Co. has said it plans to introduce more than 50 new vehicles by 2025 and increase local production for Ford and Lincoln brands in China. VW, the top foreign brand in China, plans to invest about 4 billion euros ($4.5 billion) in the country in 2019 together with partners.

General Motors Co. will continue to invest “wisely” in China and manage the capacity, which is sufficient to meet projected market demand over the next several years, a spokeswoman said in an email. A Ford representative said the carmaker schedules production based on market demand and works closely with dealers to manage inventory. The U.S. carmaker plans to bring five more vehicles for local production this year to further drive its growth in China.

Some have already scaled back operations. Suzuki Motor Corp. exited the country in 2018 after its smaller cars failed to gain traction, while Chinese consumers staying away from showrooms forced Jaguar Land Rover to shut a factory temporarily.

Economists see growth of the world’s second-largest economy slowing to 6.2 percent this year from 6.6 percent in 2018, as uncertainty over the trade war couples with a decline in consumer confidence to dim the outlook.

“Overall economic growth is the key factor for passenger car demand,” said Patrick Yuan, an analyst at Jefferies Hong Kong Ltd. “Continuous growth of the car market comes from consumers’ rising disposable income and expectation of that.”

Electric Hope

Carmakers are now increasingly placing their bets on electric vehicles, which are gaining popularity amid China’s environmental policies. Wholesales of electric cars, plug-in hybrids and fuel-cell vehicles may rise by about a third in 2019 to 1.6 million units after topping the 1 million mark for the first time in 2018, the CAAM predicts.

Tesla Inc. is accelerating its push in China with a planned manufacturing presence, and the U.S. company will compete against electric cars by global brands such as Volkswagen AG, BMW AG and GM as well as dozens of local manufacturers seeking a piece of the pie.

While the EV numbers are still small—just a few percent of total car sales—the growth rates are impressive. An early foothold in electric-car sales puts a brand in better position to reap the rewards down the road, when such vehicles are expected to surpass gas guzzlers.

Like in other areas of China’s economy, government policies to a large extent dictate the car industry’s fortunes. And now the state it putting all its might behind electric vehicles, introducing stringent rules to promote the sale and production of greener cars. Major manufacturers will be punished unless they meet quotas for zero- and low-emission cars or buy credits from other companies that exceed the quotas.

“Electric vehicles will continue to gain share, accelerated by mobility services, car plate restrictions on gasoline-powered cars and the dual-credit scheme,” said Bill Russo, founder and CEO of Shanghai-based consultancy Automobility Ltd. “Vehicle sales maybe flat or declining, yet the market is being served more efficiently with shared mobility.”