Last week, the world’s leading newspaper headlines screamed out the downgrading of the US from a triple AAA rating to AA+, the notch below the blue-chip rating. It was the first time that the US has been downgraded since 1917 and came in the aftermath of weeks of intense talks within the American government to stave off an almost-certain default on its debt obligations. For many, Standard & Poor’s downgrading of the US brought back the fears and ghosts of the closure of Lehmann Brothers in the autumn of 2008.
The question being asked now in the world’s financial capitals is whether the world is headed for another recession. While the Indian political and financial establishment was quick to assuage fears of the US crisis impacting India, most certainly, India Inc held its breath, even if for more than just a few moments.
For the automotive sector – the focus of this magazine – the immediate reaction of the heads of companies is that in the short term, the impact will be minimal. The sector is coming to grips with a slowdown in sales, especially in the passenger car sector, following the 10th increase in repo rates by the Reserve Bank of India.
Uday Phadke, president – finance, legal and financial services sector, Mahindra & Mahindra, said: “The rise in lending rates may affect some of our plans. But our overall plan of investing Rs 5,000 crore between FY 2011-12 and FY 2013-14 will remain unaffected. Depending on ground realities, we may defer or advance some of our activities.”
This comment can be taken as broadly reflective of the sentiments within the automotive sector in the country as well. Apart from the interest rate hikes, the passenger car segment has been battered by increases in the prices of petrol (by Rs 5 a litre in mid-May 2011) and Rs 3 per litre for diesel (which, unlike petrol, has not been de-controlled) in July 2011.
Car sales have fallen to their lowest in two years. This will certainly have repercussions across the sector from dealers, consumers and small and medium size enterprises. Autocar Professional spoke to variety of stakeholders and macro-economic experts to gauge the mood within the auto sector.
After a turbocharged growth of 30 percent in the automotive sector which saw sales rise to 2.4 million in 2010-11, sales have fallen steadily. Sales in July 2011 touched a new low with the top three – Maruti Suzuki, Hyundai Motor and Tata Motors – seeing sales fall.
Already, industry body, the Society of Indian Automobile Manufacturers (SIAM) has gone on record to say that the sector will grow by 10-12 percent in the current fiscal as against 16-18 percent last year.
A north India-based component supplier, (who requested anonymity) who counts Maruti Suzuki as one of his customers, says that as a result of the slowdown, he has had to idle some of his machines. This is not something he had expected last year when he was operating his factory on three shifts, seven days a week. “We are now down to running the plant on just six days,” he says.
Tata Motors, which has recently launched a new version of its crossover Aria, has already felt the heat of the recent slowdown. Commenting on the impact of the recent step by the RBI, Rajesh Nair, head – utility vehicles product group, Tata Motors, says: “It has affected the retail sales. Over the last six to eight months, interest rates have gone up by eight percent. In semi-urban and rural areas, it is even more because of the credit risk profile of different customers.”
Incidentally, in Tata Motors' 2010-2011 annual report, chairman Ratan Tata said: “The quarterly growth figures in Asia have been declining during the year and it is expected that both China and India will register lower growth rates in 2011-12. There is therefore a likelihood of a general slowdown in industrial activity in Asia compared to the growth rates achieved over the past few years and possibly a noticeable drop in consumer demand for goods and services.”
“Inflation rates have risen and the central banks in India and China have initiated measures to slow down their economies to curb inflation. The resulting higher interest rates, tighter credit regimes and higher fuel costs will dampen consumer demand for a range of consumer products including automobiles," he added in his message to shareholders.
The head of Pune-based Delux Bearings, Kirti Rathod says the interest rate hike will impact the tractor and commercial vehicle sector. But in the car sector, Rathod avers that new models will get the attention of the consumers in the 60-75-day period starting in mid-September.
Expect more rate hikes - With Union finance minister, Pranab Mukherjee indicating that this will not be the last raise in interest rates, OEMs and vendors have to brace for future rate hikes. Already, the spike in interest rates has made automotive loans costlier, especially as over 70 percent purchases are made through financing institutions. Moreover, cost of production will also scale up thus increasing automobile costs. And with parliament having just begun its monsoon session, one head honcho said that if the government does move on decisions such as FDI will help improve the overall sentiment.
According to Vinnie Mehta, executive director of Automotive Component Manufacturers Association of India (ACMA), the sector operates more in tandem with vehicle production rather than sales but sales eventually impact production schedules and in turn, the component chain. OEMs, in the meanwhile, are yet to communicate any changes in supply schedules to the component makers.
“Vehicle sales have been adversely affected in the last three months due to inflation, raising cost of capital for manufacturers. As a result, costs have to be factored into the final product, having a counter effect on production and consumption of auto components,” explains Mehta. However, he considers it as a short-term aberration and feels that with the festive season around the corner, vehicle sales are likely to pick up. In an industry where imports of components far exceed exports, vendors are likely to feel the heat in accessing capital from banks, especially when international interest rates are much more competitive giving foreign component makers an advantage. But according to Mehta, imports will be equally impacted by the rising cost of capital restricting their inflow. The good news, though, is that the aftermarket may not feel the pinch too much.
ACMA has recommended to the Planning Commission that an Interest Rate Subvention Fund of Rs 3,000 crore be incorporated in the next five-year plan ranging from 2012-17 to help the micro, small and medium scale enterprises (MSMEs) in the auto component industry.
Mehta says that the fund will enable MSMEs to avail a subsidised rate of interest on inputs. The recommendation is that of the total, Rs 800 crore should be earmarked for lightweighting initiatives, Rs 1,000 crore for engine and powertrain development and Rs 1,200 crore for manufacturing technologies and efficiency improvements, testing and validation processes for helping the industry.
Banking on the festive season - In general, captains of industry say that over the long term, festive season sales are likely to offset the losses on higher priced loans and on rising EMIs. Furthermore, the downward trajectory of oil prices is expected to cool off commodity prices in the long-term, lowering cost of production to some extent. While OEMs have begun to feel the downslide in sales, they have been optimistic about a turnaround during the latter part of the year when sales gain momentum.
Sridhar Chandrasekhar, Head, CRISIL Research, said: “The fall in volumes clearly manifests weakening consumer sentiment over rising cost of car ownership. Model launches, along with the onset of the festive season will, however, revive sales growth in the second half of 2011-12.”
H S Goindi, president – marketing, TVS Motor: “We haven’t seen any direct impact of the repo rate hike by the RBI in the two-wheeler business. If at all, there could be some indirect impact as other expenses of consumers like EMIs on home loans, personal loans, food prices have gone up. As of now we are watchful of the situation.”
Maruti confident about growth - While being concerned about declining sales on the back of its longest labour strike of 13 days followed by almost a week of maintenance shutdown in end-June, Maruti Suzuki has given the green signal to its suppliers in a recent vendor meet, indicating that they should proceed with their long-term investments as the current dwindling sales will be limited to a short term.
Maruti is gearing up for the development of its small car portfolio for the Japanese market for Suzuki and will require additional resources in terms of components for the new models.
For instance, one Maruti supplier, the Rs 40 crore Faridabad-based PYN Precision Components whose 90 percent supplies go to Maruti Suzuki is going ahead with its expansion plans. However, managing director Kishore Gupta feels that capital expenditures will have to be trimmed wherever funding has to be sourced through debt. “We will have to reassess future projects, reduce their profitability and revisit their costs,” he elaborates.
While capacities that have been built will not be impacted, the hike in interest rates may well impact capacities that come online in end-2012 and go on to 2014. Larger capacity increases may likely be on hold but not those in the region of 50,000 units or so, says one supplier.
Maruti Suzuki’s sales have dipped almost 20 to 25 percent in the last two months across different models except the Alto and Eeco. But Mayank Pareek, managing executive officer, marketing and sales, Maruti Suzuki, expresses concern that with most vehicle sales being funded through bank loans, consumers will end up paying more for the products. Moreover, all major players have shown declines. But he is optimistic that this will be a temporary phase with sales expected to pep up during the festival period starting next month and translating into an upswing of 15 to 18 percent in car purchases.
Ford India has been riding high on the popularity of its Figo and the new global Fiesta. Anurag Mehrotra, vice-president – marketing, says that despite the fuel price increases and RBI’s interest hikes, the Figo and Fiesta Classic are faring well particularly in Tier 2 and Tier 3 cities. He says he does not see much threat to Figo exports either as the cars are mostly headed to South Africa and the Asian countries. Even in other regions, he feels that exports will not buckle under pressure.
Abdul Majeed, India Leader for Automotive Practice, PwC, is of the opinion that the downgrading of the US credit rating by Standard & Poor could impact the availability of credit from banks for exports. As regards the RBI hike, he says: “Consumer sentiment is based on finance and if cashflow is impacted, inflating EMIs, customers may postpone their purchases. Component makers will have less capex at their disposal for future investment outgo.”
S G Murali, executive vice-president, finance of TVS Motor Co, says: “Continuous increase in rates of interest, higher inflation and a lower-than-projected GDP growth for the country points to a subdued growth of two-wheelers. We hope the recovery of economic activity after the festival season will revive the market. It is important to focus on growth and give a boost to the Industries in India in view of weak global economic outlook. Perhaps, RBI has reached the end of the curve on rate tightening and will start easing in the second half. An RBI boost to retail finance industry will certainly help. Activities at the dealerships are not affected so far. We look forward to a good festival season. We have adequate capacity and hence do not need any major capital expenditure. All our brands are strong and the innovative features of our products and good fuel efficiency offer the right value to our esteemed customers.”
Also, with global uncertainties accompanied with the cooling off of oil costs and commodity prices offset by the US downgrade, demand for vehicles could dip. But Majeed is of the opinion that if OEMs offer sizeable discounts and facilitate financing, sales numbers could revive. But if interest rates continue to climb during Q3 and Q4, passenger vehicle sales could well end at eight to 10 percent growth during FY’12.
Volvo Buses cautious - In the bus segment, Akash Passey, managing director of Volvo Buses India, has not felt any impact so far as buses are not a short-term investment. But he says that bus purchases by the private sector could face a negative fallout. Buses that are acquired by city and State transport undertakings will however be cushioned against price hikes.
Volvo Buses has about 150 customers of which about 30 are institutional buyers and the rest, private. Passey feels that if the interest rates continue to rise, then the company could feel the impact of the price hike. He remarks that the general scenario is essentially demotivating on all fronts, whether political or economic. Furthermore, the sudden downgrading of the US credit rating is likely to make exports five to 10 percent costlier for customers. “More than the US downgrading, the immediate concern is the exchange rate that can affect material cost and imports across the world for a global product,” he adds.
The same thoughts are reiterated by Venki Padmanabhan, CEO of Royal Enfield who, while saying that it is too early for any conclusion to be drawn about the future of exports, remarks, “What needs to be watched is the currency and the fluctuations of the rupee versus the dollar.” Recently, the rupee fell against the dollar and that does not augur well for exports.
“We are niche makers of bikes and our customers make cash payments, so our sales will not be affected by the RBI interest hike. But for component makers who borrow loans for production, production costs could rise,” he says.
On the other hand, Angel Research analysts feel the recent hike has extended the monetary tightening but it is close to the peak of the current interest rate cycle. They do not expect material hike in deposit rates and in overall cost of funds on account of the latest repo rate hike by the RBI as credit off-take is itself showing signs of moderation on account of increase in overall macro-economic risks and the higher interest rates impacting demand.
The analysts see cooling global commodity prices, moderating food inflation (at two-year lows), weakening domestic demand, slowing credit (down to sub-20 percent levels) and higher deposit mobilisation, as signals that the economy is close to the peak levels for both inflation and broader interest rates. The key risk factor is the longer-than expected persistence of global commodity and energy prices at higher levels.
Fallout on HR - The slowdown will also have its effect on the human resources segment. Rathod saus that if the rate hikes continue to bite, there will likely be an impact on hiring. Companies may well move to hiring more contract staff but says resources dedicated to R&D will most probably not be impacted. However, overtime will be cut and the number of contract staff may likely reduce over the short term.
One of Maruti’s suppliers who attended the recent vendor meet says that Maruti, despite the current slowdown, wants vendors to build capacity. It does favour its suppliers working two shifts and giving the machines a rest. One supplier actually asked if Maruti would help out with loans on easier terms. Clearly, this makes sense for the smaller players who wish to lower costs.
A source at the Pune-based SIDBI says that over the last two years, rates of loans over Rs 25 lakh have gone up from 11.5 to 12.5 percent through to 13.5 percent. The sectors that have been impacted are the proprietary and partnership-based companies. Only by investing in energy-saving equipment as part of technology upgradation can auto players avail of some sops, the source added.
Sachin Mathur, an automotive forecaster and consultant, has said that the real impact of a fall in investment growth is typically long term. Over time, it creates a tightness in manufacturing capacity which can then ironically push up prices of manufactured good. There can thus be a long-term effect on overall GDP growth.
Inflation is an issue that governments are sensitive about because of the impact that it has had historically on vote banks. With higher interest rates and consequently higher borrowing, business and its ability to create jobs over the medium-to-long term get impacted.
Earlier this month, the government’s economic advisory council lowered its GDP growth projections for 2011-12 to 8.2 percent.
The council, headed by former RBI governor C Rangarajan, had earlier estimated that the economy would clock nine percent growth this year. In its
latest economic outlook, it expressed serious doubts about the government’s ability to keep fiscal situation under control to control inflation that will likely remain high till October 2011. The council’s verdict differs from finance minister Mukherjee’s estimate of 8.75 percent growth.
The Indian automotive sector is in the midst of implementing the ambitious Automotive Mission Plan 2016 which aims to enhance the component sector's global reach and create 25 million jobs, among other things. It remains to be seen whether the current slowdown will impact this. Companies that strategise for the long term will reap the benefits.