Further details have emerged regarding the proposed transaction between Guangzhou Automobile Group (GAC) and FAW Group, as China continues to pursue consolidation in its automotive industry to address production overcapacity.

GAC Group has announced plans to acquire a stake from FAW Group in an unspecified car-manufacturing venture by issuing GAC shares to FAW in return. The proposed transaction, outlined in GAC's recent filing, would result in FAW becoming GAC's second-largest shareholder. As both companies manufacture Toyota models in China, analysts said the move likely indicates that the two state-owned companies are planning to combine those operations.

China has long called for consolidation to address production overcapacity in the world's largest automotive market, although previous efforts have not resulted in significant consolidation. The proposed transaction between the two state-owned companies could provide a different approach to addressing excess vehicle production.

Rather than seeking to combine competing carmakers backed by different local governments, an approach that has previously faced difficulties, China appears to be targeting foreign-brand joint ventures for consolidation. This could allow production capacity to be reduced while limiting the impact on domestic stakeholders. Under such an arrangement, both enterprises would remain independent while reducing capacity.

"This transaction is a precedent for SOE integration in China's auto sector and could be a critical test case for deeper SOE integration," a credit analyst said in a research note published on September 15th. "The FAW-GAC transaction shows cross-region SOE integration is feasible." Merging state-owned enterprises has historically been difficult because of issues including employment concerns and regional protectionism, the credit rating company said.

Closely held FAW, which is based in the north-eastern Chinese city of Changchun, would become the second-largest shareholder of GAC, which is based in southern China's Guangdong province, according to a securities filing on the Hong Kong Exchange. GAC, FAW and Toyota Motor Corp. either declined to comment beyond the statement or did not respond to queries.

Despite the lack of details, investors responded to the announcement by sending GAC shares up 16 per cent in Hong Kong trading the day after it was announced. The stock ended 2.6 per cent higher on September 15th.

China's automotive industry has been subject to consolidation pressures for several years, as dozens of new entrants sought to capitalise on the country's transition to electric vehicles by building manufacturing facilities. China now has sufficient production capacity to manufacture more than 55 million vehicles a year, according to the latest data compiled by a local research institute.

However, domestic sales were fewer than half that amount last year, according to the China Passenger Car Association, resulting in more vehicles being produced than the domestic market could absorb. Some of this excess production is being exported to overseas markets. Data from the China Association of Automobile Manufacturers showed that exports increased by 21 per cent to more than 7 million vehicles. This has contributed to trade tensions.

The surplus production of vehicles is also affecting industry profitability in China, as Chinese carmakers seek to compete on price by reducing vehicle prices.