* Market shrinks 14 pct in Jan, production down 34 pct
* Not all production plants will survive
* Scrappage incentive expected to lift demand
(Adds comments from EU commissioner, Peugeot manager)
By Christiaan Hetzner
FRANKFURT, Feb 3 (Reuters) - New car sales in Germany, western Europe's largest auto market, contracted in January at a double-digit rate as Germans tightened their belts in anticipation of the worst recession since the Second World War.
In what carmakers believe could be the third straight year of record low car sales, new registrations in Germany sank 14.2 percent to 189,385 light vehicles last month, the German motor vehicles department KBA published on Tuesday.
Data showed car production down 34 percent in January amid an export slump of nearly 39 percent in Germany, highlighting an acute threat to the over 700,000 people employed in the domestic automotive and parts supplier industry.
"There is no guarantee that all production sites in western Europe will still be there," EU Industry Commissioner Guenter Verheugen said in an interview with Reuters on Tuesday, citing the 20 percent overhang in manufacturing capacity.
In spite of his warning not to incite a backlash among trading partners through protectionist state aid, a much-needed boost to carmakers could soon be in the cards thanks to a considerable increase in new orders as Germans take advantage of Europe's most generous government scrapping incentive.
Berlin is offering a 2,500 euro subsidy for each buyer of a new car in exchange for turning over the keys of older ones registered nine years ago or more.
The head of Peugeot's German import subsidiary expects to profit substantially from this scrapping premium, estimating the so-called "Environment Bonus" could add another 300,000 vehicles to the overall German market over his forecast of 2.7 million.
"The mood among Peugeot dealers is currently as good as it has been in a long time...Orders rose 80 percent in January over the previous year," said Olivier Dardart, who has 400,000 customers alone that could swap their old Peugeot for a new one.
According to the KBA motor vehicle department, the owners of around 13.7 million cars qualify for the state "Environment Bonus" -- roughly a third of all vehicles registered in Germany.
Car companies have long pushed for scrapping incentives as the quickest and most effective way of reducing carbon emissions from vehicles.
The VDA association of German automakers argued that lowering the average age of cars on German roads by just one year from the almost nine years at present could lead to a reduction of 2 million tonnes of carbon dioxide.
CARBON FRIENDLY
It has forecast 2009 sales could exceed the 3 million mark thanks to legislative incentives including the scrappage incentive and car tax exemptions for as long as two years for buyers of new vehicles fulfilling stringent Euro 5 emissions norms.
New registrations of mini cars, that include the Czech-built Peugeot 107, grew in January, against the trend, rising 34 percent in Germany -- roughly in line with the increase in demand for cars emitting up to 120 grams of carbon dioxide per kilometer that in the future will qualify for tax breaks.
Starting in July, the owner of a Smart ForTwo 1.0 litre petrol vehicle only has to pay a 20-euro base levy per year, instead of 67 euros previously, since it emits only 112 g/km of CO2.
"Every tenth vehicle (registered in January) is thus below the planned car tax threshold," the KBA said, adding that Euro 5 cars reached a share of nearly 17 percent that month.
The government incentives will prove critical in boosting a German auto industry as the country endures what the International Monetary Fund expects will be a contraction in economic output by 2.5 percent, by far the worst since 1945.
Without the artificial boost to demand, the German car market would almost certainly retreat from last year's level of 3.09 million vehicles. ($1=.7776 Euro) (Additional reporting by Ilona Wissenbach in Brussels; editing by Simon Jessop)