'GST will work for the auto sector, provided prices are lowered.'

The response of the Indian automobile industry will be the ultimate test for the success of the GST as it is quite singular based on past experience where the impact tends to be different.

By Madan Sabnavis, Chief Economist, CARE Ratings calendar 08 Aug 2016 Views icon9235 Views Share - Share to Facebook Share to Twitter Share to LinkedIn Share to Whatsapp
'GST will work for the auto sector, provided prices are lowered.'

The response of the Indian automobile industry will be the ultimate test for the success of the GST as it is quite singular based on past experience where the impact tends to be different.

There are three aspects to the working of the GST and the final impact on prices and demand. First is the final rate that will be announced by the government. While it was expected to be 18 percent earlier, there is some talk of it being higher especially if the states are to be fully compensated as the state taxes are just about a little less than central taxes in most cases. A rate of 20 percent looks likely, though the judgment will be out soon.

Second, when the impact on any industry is analysed, the cost factor has to also be taken into account. While the GST rate on final automobiles especially two- and three-wheelers and regular passenger cars would most definitely come down by 5-7 percent on an average basis, there would be an increase in costs too as the rates on various inputs that go into the manufacture of the final vehicle could increase. Therefore, the ability of the company to lower the final price will be restricted by the cost factor too. Rubber products, plastic parts, steel, batteries and paint, among other inputs, would all be affected in a different manner and depending on the share of these costs in total, the net effect would be determined.

Third, there should be willingness of the company to lower the final prices even if the first two caveats are met. The corporate sector has been going through quite a bit of pain with profits under pressure for the last three years. This being the case, the companies may try and hold on to the existing price or lower them only partially. The argument is that once a consumer is used to paying a certain price and does not mind it, then lowering the cost is not necessary. This has been noticed in several FMCG goods, where the consumer may not finally pay a commensurately lower price resulting from these changes in taxes.

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But the auto sector is different as this is probably the only segment where it has been noticed earlier that the prices did come down when the government lowered the excise duty for a specified time period. The lower prices did help to increase sales of the same, which is what holds hope this time too. One of the factors which enables better transmission is that typically companies do not want to hold on to excess inventory as the cost is significant. Hence, there is tendency to pass on the benefit.

The other reason is that the element of competition is high, given the number of players and the state of demand. While for FMCG industries there does tend to be some degree of cartelisation, in the auto sector the players are constantly competing by reducing prices and providing other benefits to ensure that they are able to carve a larger part of the market. 

In fact, it can also be expected that bank finance for the same will continue to increase as the banks are less willing to lend for long-term projects and auto loans within the retail category with mortgages are attractive options. Therefore, this could also have the enabling finance support that will be beneficial for demand.

Further, at the export level, which is pertinent for the two-wheeler segment, prices are generally more elastic in the downward direction as companies compete in the global market to garner a higher market share.

Last, the luxury segment would remain relatively unaffected as the price does not matter and where the snob value is high. Also to the extent that several vehicles are purchased by companies and the government for use by their officials, such changes are less likely to influence decisions.

On the whole, GST is positive for the auto sector and the critical part will be that the companies will have to pass on the price benefit to the consumer which will encourage demand and hence production.

The views expressed by the author are personal

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