The auto industry, a main engine in China's economic recovery over the past two years, may be decelerating as the possible expiry of stimulus incentives, additional taxes and slower economic growth put the brakes on its rapid expansion, according to industry watchers.

In the first 11 months of this year, China's auto sales surged 34 percent on an annual basis to 16.4 million units, according to the China Association of Automobile Manufacturers.

For all of 2010, sales of passenger cars, buses and trucks are expected to rise 28 percent to 17.5 million units, maintaining China's position as the world's largest auto market, the China Passenger Car Association said.

That follows a robust 2009, when sales powered ahead 46 percent to 13.6 million units.

"The booming sales of the last two years have overshot potential demand in the near future," said Yang Zaishun, vice secretary-general of the China Passenger Car Association. "Next year may see milder growth of between 10 percent and 15 percent."

Rao Da, secretary-general of the car association, agreed, saying it will take time to create new demand at such high levels.

"It is reasonable to expect year-on-year sales growth to drop in the first quarter of next year," Rao said, citing the likely expiration of preferential purchase taxes, of subsidies on car purchases by rural residents and of tax incentives for people who turn in older, gas-guzzling clunkers and buy new fuel-efficient cars. He also pointed to generally slower economic growth as China tightens credit.

"The expiry of stimulus packages could reduce sales by more than 1 million units, while slower economic growth could lead to smaller, even zero growth, in the commercial sector," Rao said.

Media reports claim the preferential purchase tax will definitely be scrapped next year.

China halved the 10 percent purchase tax for vehicles with 1.6-liter engines or smaller to 5 percent in 2009 and allowed it to rise to only 7.5 percent this year, which helped the country overtake the United States as the world's largest auto market.

"The cancellation of the preferential purchase tax will affect first-car buyers, who are very price sensitive," said Wu Hao, a Dongfeng Citroen dealer.

Subsidies on vehicle purchases by rural residents and on upgrading to new cars are also due to expire next year.

In the first three quarters, China earmarked 8 billion yuan (US$1.2 billion) to a program subsidizing rural vehicle purchases. That accounted for estimated sales of 2.1 million vehicles.

Meanwhile, for the January-November period, subsidies on trading old cars in for new boosted auto sales by some 38.2 billion yuan.

"If the stimulus packages end at the same time, the auto market and auto makers will be thrown into quick reverse," Yang said.

Such actions would be inconsistent with the nation's call to boost domestic consumption, industry watchers said.

Some in the market speculate that some subsidies may be extended, but with stricter rules imposed.

"It would be better to phase out the policies gradually in order to buffer the possible impact to the market," Yang said.

Many of China's smaller cities have pinned their development hopes on increased auto sales in the next few years.

"The real opportunity for domestic consumption is in the second, third and fourth-tier cities in provinces such as Shandong, Fujian and Guangdong, where the growth in the middle class and consumer confidence have been rising faster than in first-tier cities," said Shirley Ng, a researcher from Nielsen Co's China region.

Aside from government incentives being withdrawn, auto buyers also face the risk of additional vehicle taxes.