Volkswagen's (NASDAQOTH: VLKAY) admission that it cheated on emissions tests for years has governments around the world outraged -- and VW scrambling to figure out how to fix the 11 million affected cars.
VW is one of the world's largest automakers, and it has the biggest share of the world's largest new-car market, in China. VW has never sold diesel-powered cars in any significant quantity in China, and it was thought that the Chinese government would have little to say about the scandal.
But that may not be the case. The Chinese government turns out to be very concerned about VW's cheating ways.
And of all of the potential costs of this scandal, trouble in China could end up hurting Volkswagen the most.
China's government is "highly concerned"
China's quality-watchdog agency said on Monday it was "highly concerned" about VW diesels equipped with software designed to cheat on emissions tests. It said it would take measures to address the issue, but -- beyond demands that VW act as soon as possible -- it didn't give specifics. Separately, China's environmental ministry also said on Monday that it would launch an investigation into VW's actions.
That's somewhat surprising, given VW's direct exposure from the scandal in China is tiny. Fewer than 2,000 diesel-powered vehicles with the cheating software were sold in China. That pales next to the 482,000 in the U.S. and the millions in Europe. Importantly, all of the cheating diesels in China were imported: None were made on Chinese soil.
But the scandal has received a lot of media attention in China, and the government is clearly feeling that it needs to act. That's bad news for VW.
Problems in China could hurt VW very badly over time
China is massively important to Volkswagen, accounting for about a third of its total global sales. Through August, it sold 2.26 million vehicles in the country. Its Audi brand has been the market-share leader in China's booming luxury-car market for several years now. It earned over 5 billion euros ($5.7 billion) in China last year.
A slowing economy has hurt new-car sales in China this year. Through August, China's overall new-vehicle sales were down about 2.6% from the year-ago period. But VW Group's China sales were down about 5.6% this year through August, as rivals at the low and high ends of the market put increasing pressure on VW's offerings.
That wasn't a huge concern for VW-watchers: Ebbs and flows happen. Now, though, things could get much worse. If China's government has decided to pressure or censure VW, that could affect VW's ability to get future models approved. It will likely also subject VW's other models to far greater regulatory scrutiny. Translation: More demands for costly quality recalls that VW will have limited power to resist.
The upshot: There's nothing good for VW in this news
Long story short: Today's developments suggest that China's government is taking a critical interest in VW's global emissions-cheating scandal, even though it affects very few vehicles in China. If China's government decides to put heavy pressure on VW, that will raise the cost of doing business in the world's largest auto market.
Sustained pressure from the government could also negatively affect VW's standing with Chinese consumers, opening the door for big rivals like General Motors to gain market share at VW's expense. Over time, that could be even more expensive for VW than the costs and fines it will face elsewhere. Watch this one closely.