Some carmakers have also questioned whether the central government will be able to enforce a nationwide policy.

The new policy lifts all restrictions on the use of compact cars, including existing bans on using such vehicles as taxis.

In a report on its implications, investment bank ABN Amro says the new policy, if successfully enforced, will boost compact-car makers such as Changan Auto and Geely Automobile Holdings.

Analyst Fan Cheuk Wan also expects additional fiscal measures favouring compact cars to be unveiled later.

The share price of listed carmaker Geely jumped 10.81 per cent after the announcement.

However, while welcoming the news, Geely executive director Lawrence Ang questioned whether enforcement would be possible.

'We are seen as the beneficiary. But we doubt the practical outcome of the policy as it affects the interests of local governments,' Mr Ang told the South China Morning Post.

'Until we make sure there is positive implementation of the new policy, we will not easily develop new products. This is too dangerous.

'We understand that it is difficult for the central and local governments to work coherently, although, most of all, we do welcome the new policy.'

China's car industry has been aggressively promoted by policymakers as an engine of economic growth and employment behind a curtain of local protective measures.

But, as local governments have climbed aboard the bandwagon and vied with one another to build bigger car plants, capacity has outstripped demand.

Chen Bin, head of the industry department of the National Development and Reform Commission, was quoted in the China Securities Journal as saying that, by 2010, car production could reach 20 million units annually against a forecast demand of nine million units.

However, while local governments did have policy measures in place that discriminated against small cars, many of these were not implemented, said Yale Zhang, director of the automotive consultancy CSM Worldwide.

Another carmaker likely to benefit if Beijing gets its way is Hong Kong-listed Dongfeng Motor Group, which welcomed the announcement.'We forecast 20 per cent to 30 per cent growth in sales this year compared with last year,' said company secretary Hu Xindong.

'Protectionism did exist in some provinces a long time ago, but the markets are now open enough for different car manufacturers to penetrate,' Mr Hu said.

'There are no difficulties for our company exploring new markets in different provinces.'

SMALL BUT CLEAN

Many local governments ban small cars to project ventures

Carmakers such as Changan Auto and Geely will benefit

The move faces opposition from local governments