OREANDA-NEWS. The ongoing emissions investigations by manufacturers and regulators may offset the positive effect from the recovery in new car sales in Europe, Fitch Ratings says. However, we do not expect any immediate impact on European manufacturers' ratings from recent announcements and emissions test results.

New passenger car sales continue to rebound in Europe with sales growing 9.3% in 2015 and 8.2% year-on-year in 1Q16. Sales remain approximately 10% off their 2007 peak and we believe that the potential for increased sales remains significant in the region. We currently assume growth of 5%-6% in Europe in 2016 from a combination of pent-up demand and still broadly favourable economic conditions.

However, we believe that the intense media coverage of the findings from the investigations and global regulatory probes is weighing on public sentiment towards the car industry. We do not expect a major, direct and immediate impact on new vehicle sales. However, an erosion of consumer confidence in manufacturers, leading to further pressure on pricing, and an increasing debate around the role of cars is possible. This could ultimately constrain the mid- to long-term growth prospects for new car sales.

While public pressure is mounting on European manufacturers to cut emissions, this is not an entirely new issue for the sector and we had already incorporated a tightening of emission legislations into our ratings. The financial profiles of the German manufacturers, which are most exposed to tougher emission limits due to their more powerful engines and greater proportion of diesel vehicles, are strong for their ratings. We also believe European manufacturers will be able to absorb an increase in investment.

Nonetheless, we believe that pressure has increased from regulators to tighten emission legislations and testing procedures and accelerate the move to real-world emissions testing. In Europe, growing concern over the health impact of nitrogen oxide is likely to encourage the shift away from diesel engines towards petrol, hybrids and electric powertrains. A shortening of deadlines and an acceleration of the reduction in emissions thresholds could mean a sharp increase in capex and R&D, and weigh on our profitability and free cash-flow projections. This could ultimately put pressure on ratings if new global requirements are substantially different from the ones already set by regulators and incorporated in our assumptions.

Ratings could also be threatened if there were further revelations of fraud or major irregularities by a manufacturer on emission testing procedures. We downgraded Volkswagen to 'BBB+'/Negative in November 2015, reflecting the corporate governance, management and internal control issues highlighted by the emission test crisis.

Recent announcements include the recall by several carmakers, including Daimler and Volkswagen, of a total of 630,000 vehicles. Daimler also announced that it had opened an investigation in the US at the request of the US Department of Justice, and Peugeot said its premises had been searched by the fraud office in France. Separately, Volkswagen increased its provisions related to its diesel issue to EUR16.2bn from EUR6.7bn.

Investigations have discovered that several groups had vehicles emitting more nitrogen oxide than legally permitted, through legal loopholes or the use of engine management systems. However, so far no manufacturer besides Volkswagen has been found to be using illegal defeat devices. It was also confirmed that manufacturers' vehicles have been emitting more nitrogen oxide in real-world conditions despite passing the tests, although this is not illegal.