2019.8.14 News Data
The auto industry is in the midst of a severe slump. Policy interventions to revive the sector and the economy at large are necessary to stave off a protracted crisis
Virendra Singh, 49, is a concerned man. As the owner of Win Win Group, which operates a chain of Mahindra & Mahindra (M&M) dealerships in Madhya Pradesh, he has had to close eight of his 31 showrooms and lay off 300 people in the past few months. He estimates that his sales have dropped by 10 per cent, with customer footfall plunging an alarming 30 per cent. "Demonetisation and the Goods and Services Tax (GST) took the first toll," he says. Then came a regulatory shock. "The registration rates of both petrol and diesel vehicles in MP have been increased substantially. For diesel vehicles below Rs 10 lakh, rates have increased from 8 to 10 per cent. For vehicles between Rs 10-20 lakh, the rate has increased from 8 to 12 per cent, and for vehicles over Rs 20 lakh, the rate has doubled from 8 to 16 per cent. There is a similar hike in petrol vehicles too. This is not going to help the already stressed market." Underlying these is the distress in the rural economy.
The slump in the Rs 8.3 lakh crore automotive industry, which employs around 32 million people (directly and indirectly), is evident in the falling quarterly sales numbers and the closure of nearly 300 dealerships across India. For this to happen in an industry that was seen as a success story-with consultancy McKinsey & Co projecting just last year that India's passenger-vehicle market would become the world's third largest by 2021-has been a body blow to the Indian economy.
The entire automotive ecosystem-from original equipment manufacturers (OEMs, industry parlance for car manufacturers) to component suppliers to dealerships and aftermarket service providers-is saddled with idle production capacity and unsold inventories. And since this industry accounts for 22-25 per cent of India's manufacturing GDP, the slowdown threatens to destabilise the country's already-tottering economy. Underlining this, on July 24, Ram Venkataramani, president of the Automotive Component Manufacturers Association (ACMA), said that if improvements do not materialise, around 1 million jobs could be lost-20 per cent of the total employment in that sector.
It's no surprise then that this development has put the Narendra Modi-led government-which recently stated its aim of growing India's economy to $5 trillion by 2022 by investing in major industries like manufacturing-on the back foot. The prime minister, who made job growth a cornerstone of his first-term campaign and has frequently reiterated that promise, could also find job losses becoming a considerable political issue. Critical states like Maharashtra and Haryana, which are also major manufacturing hubs, are slated to go to the polls in the next few months.
THE NEWS IS BAD
Data from the Society of Indian Automobile Manufacturers (SIAM) illustrates how the slowdown has impacted every sector of the industry. In the past year, overall sales have fallen by almost 8 per cent, from 18.2 lakh vehicles in 2017-18 to 16.8 lakh vehicles in 2018-19. The growth rates for both private and commercial vehicle sales are in the red, the former falling since the second quarter of 2018-19 and the latter contracting since the third quarter of 2017-18. Even two-wheeler sales have been sliding for over a year, falling 17 per cent in 2018-19 compared to the previous year. And the data for June 2019, the latest released by SIAM, shows that the problem continues-vehicle sales contracted by about 22 per cent year-on-year in June, falling from 1.8 lakh units to 1.4 lakh units, with two-wheeler sales falling almost 12 per cent in that time, from 18.7 lakh to 16.5 lakh units.
Aggravating the pain is idle capacity. Car companies, in anticipation of high growth and demand, expanded their manufacturing-producing 7.21 million units per quarter in 2019, up from 5.66 million units per quarter in 2014. Meanwhile, new vehicle registrations fell by 0.32 million in June this year compared to the same month a year ago. This excess inventory further exacerbates the slowdown-per reports, at the beginning of June 2019, company dealerships were left with about half a million unsold vehicles worth Rs 35,000 crore and about 3 million unsold two-wheelers, valued at Rs 17,000 crore. "The industry expected big sales in the October-November festive season last year, leading to inventory numbers being ramped up. But sales were way below expectations," says Nikunj Sanghi, former president of the Federation of Automotive Dealers Associations (FADA). Worse, exports, which might have compensated for flagging domestic sales, have also been falling.
Colin Pereira, general manager (services), at Vitesse, one of Maruti Suzuki's oldest showrooms in Mumbai, confirms that dealerships have been grappling with this problem for over a year. "There has been a 20 per cent drop compared to last year, both in new bookings and walk-ins," he says. More telling is the fact that about 20 dealerships have already downed shutters in Mumbai, impacting multiple car manufacturers. "It's a severe slowdown," agrees FADA president Ashish Harsharaj Kale. "The biggest shock was that even the festive season didn't lead to an uptick in demand." The pain is being felt across the country, with dealerships in New Delhi reporting much the same. "I have never seen the market this bad," says Yadur Kapur, executive director of Deutsche Motoren, which sells vehicles produced by a number of OEMs, from Honda to Rolls Royce. "People are calling to ask me for jobs-people who started their careers with us. But even we are trying to rationalise and cut costs."
And the downturn is reverberating across the industry ecosystem. Maruti Suzuki, the country's largest passenger vehicle manufacturer, recently reported sharp back-to-back falls in net profit from the fourth quarter of 2018-19 onward. The company sold 4.02 lakh units in the April-June quarter this year, down 17.9 per cent from a year ago. Its chairman, R.C. Bhargava, recently told INDIA TODAY: "The magnitude of the slowdown is apparent from the figures. There are no clear signs of a revival, and as a result, capacity is lying idle. The prime minister's vision of making India a manufacturing hub by 2022 cannot be achieved without the auto sector." Ashok Kapur, president of the Auto Ancillaries Association and chairman of Krishna Maruti, a supplier of components like car seats and roof headliners, says much the same. "Everybody is really worried because we don't know how or when this slowdown will end." He has so far been able to avoid lay-offs by reducing employee shifts and salaries, but others have not been so fortunate.
HOW DID THE AUTO SECTOR SLIDE?
There are many reasons for the decline in auto sales, including the crisis at non-banking financial companies (NBFCs), the dent in consumer purchasing power as a result of rural distress, a general caution among buyers who are worried about their jobs, to a big shift in emission control standards from April 2020 that is making auto companies stop production of variants of their products.
PURCHASING POWER: The sustained distress in the rural economy has led to a significant drop in consumer purchasing power. Wage growth numbers paint a stark picture-from 2008-2012, real rural wages grew by more than 6 per cent per annum. Then, in November 2013, that trend faltered. Between May 2014 and December 2018, real wages for agricultural labourers grew at only 0.87 per cent, with non-agricultural labourers gaining a mere 0.23 per cent per annum. Worse, construction workers, one of the largest labour groups outside agriculture, saw real wages falling, reducing by 0.02 per cent per annum. Highlighting this, Sanghi draws attention to the fall in the fast-moving consumer goods (FMCG) market. "A person might need a vehicle, but they are prepared to wait-it is a discretionary purchase. However, people don't normally stop purchases of essential products-if they do, it means that purchasing power has really fallen." Bearing this out, market research firm Nielsen has lowered its growth projection for India's FMCG market to 11-12 per cent in 2019, down from 13.8 per cent in 2018. V.G. Ramakrishnan, managing director of Avanteum Advisors, also points to the long-term impact of demonetisation, announced in November 2016. "Demonetisation left a mark on the psyche of consumers," he says. This has led to consumers putting off vehicle purchases, or choosing to buy second-hand cars, which are significantly cheaper. In 2018-19, while 3.6 million new cars were sold, the number of second-hand cars sold was four million.
CONSUMER FINANCING: Another major issue is the lack of credit. In recent years, banks, burdened by the long-term impact of the NPA crisis, have not been as willing to issue loans as they once were. Dealerships report frequent cases in which potential buyers have visited showrooms and decided on a vehicle, but have not been able to complete the transaction due to a lack of financing. This is a far cry from 2009-10, when auto dealers and bank executives would roll out the red carpet for customers. Further stifling purchases is the fact that credit remains expensive-despite rate cuts by the RBI, actual lending rates are still on the higher side.
ACCESS TO CAPITAL: In recent years, financing has also become scarce on the supply side. NBFCs, a major source of credit for financing cars and dealerships, have been faced with a major liquidity crisis since late 2018, when Infrastructure Leasing and Financial Services (IL&FS) defaulted on interest payments. The IL&FS crisis was followed by a similar default by another major NBFC, Dewan Housing Finance. These defaults led to mutual funds-a major source of funding for NBFCs-massively reducing their exposure, pulling more than Rs 60,000 crore out of this sector. (In July 2018, mutual funds had Rs 2.66 lakh crore worth of investments in NBFCs. In June 2019, that number was Rs 2.02 lakh crore.) With banks grappling with the fallout of the NPA crisis-increasing collateral requirements to 50 per cent of loans-and NBFCs starved of funds, automobile dealers have found it increasingly difficult to obtain working capital, making it difficult to procure inventories.
REGULATORY CHANGES: Another source of disruption are new regulations. For instance, from April 2020 onward, all automobiles will have to meet Bharat Stage VI (BS VI) emission norms. It has also become mandatory for all vehicles to have safety features like anti-lock braking systems (ABS) and air-bags. And third-party insurance also became mandatory for all vehicles in September 2018. "Meeting the new regulations, including BS VI and safety norms, will lead to higher costs," says Bhargava. Soumya Kanti Ghosh, group chief economic advisor to the State Bank of India, recently noted that adhering to BS VI norms alone would increase prices by about 8 per cent. Preparing for this, companies like Maruti have lowered growth and production targets for 2019. Maruti has also been considering discontinuing diesel engines, with Bhargava announcing that the company will react to consumer demand. However, having just invested in developing its own diesel engine, it is unlikely to do so in a hurry. "It is likely that Maruti will discontinue its 1.3 litre diesel engine, for which it pays royalties to Fiat," says an industry expert.
And there are still other regulatory changes disrupting the market, such as new axle-load norms and the government's push for increased use of electric vehicles via reductions in GST rates. On the first count, in July 2018, the government increased the maximum load limits on transport vehicles by 20-25 per cent. While this reduces logistics costs, it has led to a reduction in sales of new commercial vehicles. Secondly, on July 28 this year, the GST rate for electric vehicles was cut from 12 per cent to 5 per cent, with a corresponding reduction in tax for electric vehicle chargers, from 18 per cent to 5 per cent.
What has unsettled the industry is the somewhat ad-hoc rollout of these rules. As Sanghi says, "These changes have confused OEMs, vendors and consumers," adding that the confusion will likely continue till April 2020, when the BS VI regulations are fully implemented. Overall, the policies on mobility-enhanced safety and emissions standards, encouraging the use of electric vehicles (but without the necessary ecosystem in place)-have left consumers and the entire auto industry ecosystem confused.
There is no demand private investmentso where will growth come from? It doesn’t fall from the heavens Rahul Bajaj Chairman, Bajaj Auto (Photo: Reuben Singh)
The scale of the crisis has caught even the most seasoned industry professionals by surprise. "Even if I add up all the reasons for the slowdown, it doesn't explain what we are seeing," says Pawan Goenka, managing director, M&M. "There is something about consumer sentiment that is causing the slowdown. My concern is that the worst is not over," he recently told the media. Rajiv Bajaj, managing director, Bajaj Auto, agrees. "I don't know why things have slowed down. Until September , everyone was gung-ho," he says. His reasons for the slowdown include the cyclical nature of auto sales, the liquidity issue triggered by the IL&FS debacle and the increases in insurance and fuel costs. ACMA's Venkatramani also points to changes in the transport ecosystem, like the advent of taxi aggregators like Ola and Uber. He also says that regulatory changes have worried the component-manufacturing industry. "Changes to safety and fuel efficiency standards are welcome, but what puts us in a tizzy is the speed at which regulations are being changed. It becomes difficult to predict when to invest and in what technology."
THE ROAD AHEAD
Responding to this slow-boiling crisis, some automakers have begun downsizing to stay afloat. For instance, Japan's Nissan Motors, which is cutting over 12,500 jobs globally, will retrench 1,700 people in India. But resorting to lay-offs comes with perils, including labour unrest. Stray incidents of labour protests have already rattled the industry. Bike maker Royal Enfield ran into trouble last year with its union over certain shop-floor rules it wanted to impose, while unrest was also reported at a Yamaha factory after management reportedly protested against employees forming a union. However, any long-term solution requires sales to rise. Gaurav Vangaal, an analyst with IHS Markit, estimates that sales should pick up by October. "Discounts will rise by the end of this year to pep up demand," he says. Maruti's Bhargava also has similar expectations. "Data shows that before the general elections, people get cautious. After the election, they go the other way," he says. But Sanghi is not upbeat. "I do not see a correction happening in the near future," he says.
There appear to be no quick-fix solutions. Unless the economy rebounds, auto sales will remain sluggish. But there are some historical lessons that could be applied. The sector saw a downturn in 2009 and again in 2014-both times, the government stepped in. In 2009, excise duties were lowered, spurring consumer spending, and in 2014, the government announced that under the Jawaharlal Urban Renewal Mission, state governments would purchase commercial vehicles, boosting the industry.
TAX BREAKS: At present, small cars attract a cess of 1 per cent, small diesel cars attract a cess of 3 per cent, medium cars a cess of 18 per cent, luxury cars a cess of 20 per cent, and SUVs 22 per cent. This is over and above GST, at 28 per cent. Industry figures want GST reduced to 18 per cent, with M&M's Goenka suggesting that the government remove the cess on small cars and keep a single rate of cess of 17 per cent for all others for the next four to six months. "It won't lead to a major loss of revenue," he says. "And if this revives the auto industry, the returns will far outweigh the cost." Sugato Sen, deputy director general, SIAM, agrees: "Taxes on cars are almost in line with 'sin products' (those that are heavily taxed, like tobacco, to discourage sales) under GST. We have approached the government for a stimulus."
EASE FINANCE: Jagdish Khattar, former managing director of Maruti Suzuki, says that the primary problem is financing-especially in the small-scale sector, which comprises as much as 70-80 per cent of the industry. Bhargava says he hopes the government and the RBI will re-examine the collateral policy for lending to NBFCs and improve acc-ess to affordable credit. Rate cuts have not been passed on to the consumers and banks continue to be wary of lending.
STAGGER POLICY ROLLOUTS: A general view in the industry is that the government should take a staggered approach to new regulations. Bajaj points out that shifting from conventional fuels to renewables cannot happen overnight. It requires preparation and investment by manufacturers, vendors and aftermarket service firms. Some say the situation is similar to what happened in the housing sector, where a combination of regulatory changes-RERA directives-and an economic slowdown have saddled the sector with poor sales and large stocks of unsold inventory.
ECONOMIC STIMULI: Consumption cannot rise without improved consumer confidence, which requires the economy to improve. Although India is expected to grow at 7 per cent this year, bleak economic news-the lack of jobs, the downsizing in several sectors and the NPA crisis-has dampened confidence. More policy interventions are required to boost business and consumer sentiment.
Offering some hope, Bhargava says that general economic conditions are favourable. Election results have increased optimism and stability, he says, adding, "confidence in Narendra Modi is high, and these are favourable factors". That said, a quick government intervention is still necessary, as is a change of tack by manufacturers to adapt themselves to the new normal. But in the end, unless the economy rebounds, the crisis is likely to continue.