On January 1, China's Ministry of Finance cut subsidies for electric vehicles (EVs) by 20% this year, as sales of so-called new energy vehicles (NEVs)—a category covering hybrids, plug-ins, and hydrogen-powered autos—regained momentum after plunging during the pandemic last year.

China's EV subsidies reimburse buyers different amounts depending on a vehicle's range—how far it can travel on a full charge—but the standard payout last year was roughly RMB18,000 ($2,800). That discount will now be reduced to around RMB14,400.

The cut in subsidies will create more competition in the hotly contested market, where Tesla has gained a lead over local rivals since opening its Shanghai Gigafactory in 2019.

Subsidies on electric-vehicle purchases have helped China become the world’s largest market for EVs, accounting for roughly 50% of global sales. Beijing had planned to phase out the subsidies entirely by December 2020 and started rolling them back in June 2019, claiming that production had gotten cheap enough to no longer warrant government support.

But as Beijing tried to wean consumers off subsidies, China’s EV sales slowed, with the industry posting five consecutive months of declining sales for the last half of 2019. Then the pandemic hit, and EV sales plummeted a dramatic 54% in January and a greater 77% in February.

The sudden decline threatened the government's target of having NEVs account for 20% of auto sales by 2025. To get the market back on track, Beijing extended subsidy support for two years, setting a new phase-out deadline of 2022. The 20% cut in subsidies announced on January 1 is part of the new phase-out.

As Beijing granted the extension, NEV sales staged a comeback. According to the China Association of Automobile Manufacturers, China’s EV sales (which account for the vast majority of NEV sales) likely reached 1.3 million units in 2020—up from the 1.1 million units sold in 2019. The association expects sales will top 1.8 million this year.

As China's EV market grows, Tesla is vying with local rivals to maintain its market lead. On Sunday, the California company began taking orders for its new China-made Model Y at a lower price. The China-made vehicle will cost RMB339,000 ($52,000)—30% less than Tesla advertised last year. Tesla says it will apply for government subsidy support too, which could save consumers even more money when the units are delivered in February.

However, China’s subsidies typically apply only to vehicles priced under RMB300,000 ($46,000) with a notable exception granted to vehicles built with battery swapping tech—a process that allows consumers to easily replace the car’s battery once it runs dead or needs an upgrade.

Tesla abandoned battery swapping tech in 2015, opting instead to focus on creating batteries with longer lifespans. Chinese rival Nio, however, has put battery swapping tech at the core of its business model.

The New York Stock Exchange–listed company claimed last June to have performed over 500,000 battery swaps and, through a partnership with China’s State Grid, Nio plans to build an additional 100 battery swapping stations across China this year, taking its total to around 243.

The focus on battery swapping allows Nio to price its vehicles in a premium category while enticing consumers with government discounts. The company’s SUV-like EC6, for example, costs upwards of RMB368,000 ($57,000), but consumers could get RMB22,500 ($3,500) back on the price last year, because of government support.

With the government slashing subsidies 20%, that discount is being cut to RMB18,000 ($2,800) this year, pricing the EC6 above Tesla’s Model Y.