Three Factors Responsible For The Auto Industry Slowdown

Amidst the current economic slowdown, the automobile sector has received a fair share of attention. A major reason behind this is its strong upstream and downstream linkages, which makes it critically important for the manufacturing sector in India.

A word of caution though, as the automobile sector is not all of India’s organized manufacturing sector nor the Indian economy. Nevertheless, it is still an important sector as it provides a lot of employment across the formal and informal space.

Automobile sales have been down since the last eight months and this trend has continued till August 2019, which is a good indicator of sluggish growth in the second quarter of the current financial year.

For instance, Maruti Suzuki saw a decline of 36.1 per cent in domestic sales of passenger vehicles in August 2019 compared to August 2018. For all the major automobile players across the country, the story is the same.

There is an urgent need to understand the factors that are responsible for the current slowdown.

Factor 1: NBFCs And Availability Of Credit

It is well known that a bulk of automobile purchases are financed through loans and over the last couple of years NBFCs (Non-Banking Financial Companies) have increased their share of total vehicular loans at the expense of scheduled commercial banks.

The problem in the automobile sector didn’t originate at the start of this financial year; this slowdown in sales started approximately 9 to 10 months back or rather a couple of months after the NBFC crisis originated.

Interestingly, growth too started to falter from the second quarter of the previous financial year, which again coincides with the NBFC crisis combined with the steep increase in real interest rates.

Therefore, there are multiple channels through which these events would have impacted the automobile sector.

First, the squeezed liquidity due to the crisis would have restricted the ability to finance cars thereby having an adverse impact on sales. Second, the limited liquidity would have shot up the cost of financing vehicles thereby making them relatively more expensive.

The fact that overall growth was sluggish during this period too would have had an income effect on consumers, which is likely to have had them defer or rather delay their purchase of any big-ticket item, including cars, during this period.

In April, the Reserve Bank of India, in one of its papers, concluded the exact opposite as it found that credit growth has no impact on actual sales of automobiles. This finding is suspect for many reasons.

For starters, it ignores the cost of finance channel and its impact on sales. Another issue with the RBI analysis is that the data used is for scheduled commercial banks and not NBFCs; so, though the authors explain their rationale, one must take this finding with a pinch of salt.

What we do know is that there was a decline in growth of credit, and it could be either because of reduced demand or lack of availability of supply of credit. The demand argument can be explained partly through the slowdown in growth while the supply argument is intuitive because of the NBFC crisis.

Therefore, a major part of the cyclical slowdown in the automobile sector must be attributed to the NBFC crisis.

Factor 2: Shift To BSVI

The fact is that demand is sluggish. New emission standards are likely to come into effect from April next year and this has also played a role in the current slowdown.

There’s a growing expectation that deep discounts will be offered towards the end of this year as firms would want to clear their inventories of non-compliant BSIV (Bharat Stage IV) vehicles. Consequently, a sizeable chunk of demand for vehicles has been suppressed or rather delayed in anticipation of price cuts later this year.

Unfortunately, it is difficult to quantify the impact of this factor on sales but is definitely a factor that’s responsible for the current slowdown.

Petrol Prices

The RBI memo on automobile slowdown has told us what we have known since long — that petrol and diesel prices have an impact on the sale of automobile vehicles. It is well known that they both are complementary products and therefore, there’s always been some impact of petroleum prices on automobile sales.

However, the increase in petrol or diesel prices over the last 10 months or even 18 months cannot explain the sudden decline in sales.

This is the only significant variable in RBI's econometric exercise and the limited increase in petrol or diesel prices over this period further indicates the problems with their econometric model and conclusions.

Factor 3: Structural Changes — We Prefer Ola/Uber

Recently, the Finance Minister Nirmala Sitharaman suggested that the slowdown in vehicle sales can also be attributed to millennials choosing taxi aggregators such as Ola and Uber over owning private vehicles.

The statement received a lot of criticism despite it being an important factor behind a structural decline in the growth of sales.

Even the RBI in its memo has stated that the rise of Ola and Uber had an adverse impact on passenger vehicle sales. There is absolutely no denial that ride-hailing has structurally altered the demand for private vehicles.

The recent aggregated sales data shows that there has been a saturation of taxi registrations which suggests that ride hailing has had an impact on the demand for private vehicles, and now demand for taxi has also saturated.

All of this points at a structurally lower demand for four-wheelers and this phenomenon has been observed across the globe.

Consider this: a private car would cost a monthly EMI of at least Rs 6,000. Add to this the cost of insurance, servicing, routine wear and tear. Then there’s a recurring cost of petrol or diesel per km, which would amount to Rs 10,000 on an average.

Add the cost of a driver, which in Delhi would additionally cost Rs 16,000 to Rs 18,000. All of this adds up to a minimum of Rs 27,000-Rs 35,000 per month including the initial down payment for the car.

And all of this is assuming a small mid-range vehicle; the per-month recurring cost of ownership of a sedan is likely to be higher.

Contrast this cost with the average monthly cost of Ola or Uber, which is likely to be far lower. Simple estimates suggest they could be as low as Rs 18,000 or as high as Rs 32,000 depending upon the extent of travel.

But Ola and Uber come without any hassles associated with ownership and this will play a major role now thanks to the new Motor Vehicles Act, which has hefty fines on non-compliance with traffic rules and regulations.

However, this still can’t explain why two-wheeler sales are low.

While the Ola/Uber hypothesis is extremely relevant for the structural demand changes for passenger vehicles and to some extent even for commercial taxis — as there was a sudden increase in demand for the same — other commercial vehicles and two-wheelers require a separate explanation.

For two-wheelers, the fact that income growth was sluggish during this period leaves us with some explanation while for other commercial vehicles, improved efficiency post the Goods and Service Tax (GST) combined with low economic growth are likely reasons behind the slowdown.

There are many factors that have contributed to the current slowdown in automobile sales — be they lack of finance for registration charges, making the change to BSVI vehicles, or the preference for ride-hailing services.

The fact that we saw an NBFC crisis and sluggish growth hasn’t helped the sector either. Revival of the sector will require a multi-dimensional strategy that focuses on addressing the cyclical factors that have caused the current slowdown in the automobile sector.