New Delhi: India’s auto makers may soon find themselves grappling with a problem generally associated with developed economies: a glut in auto production capacity.
Analysts believe this glut may last at least through 2009 if not longer, result in more plant shutdowns and force companies to continue to offer discounts well into next year to get sales traction.
Click here to watch video
The likely temporary plant shutdowns and discounts, in turn, have the potential to negate any benefits auto firms had hoped to reap from falling steel, aluminium and other commodity prices.
“Unless demand goes up, the benefits of the fall in commodity prices will not accrue fully,” says R. Sethuraman, vice-president of finance at Hyundai Motor India Ltd. “There is a pressure on margins.”
The glut is more severe at car and truck makers than two-wheeler firms whose sales have not been as badly hit in the current slowdown.
While India’s auto makers haven’t said much so far, two factors point to them getting increasingly skittish about excess capacity.
India produced 2.06 million four-wheelers (including all cars and trucks) in fiscal 2007 compared with an installed capacity of 2.24 million, the latest year for which figures are available with industry body Society of Indian Automobile Manufacturers, or Siam.
While some capacity additions have been deferred, fiscal 2007 installed capacity has expanded by at least half a million in the 18 months since. Companies such as Hyundai India have added capacity to make 300,000 more units this year. General Motors India Ltd inaugurated a new facility at Talegaon with 140,000 unit capacity and Honda Siel Cars India Ltd doubled capacity at its Greater Noida factory to 100,000 units.
In addition, Maruti Suzuki India Ltd, the country’s largest car maker, is on target to expand its new Manesar facility to 300,000 by 2010 from 100,000 in February 2007.
But, with a slowdown in sales (just 1.55 million in April-November and a measurable demand contraction), companies are already hard-pressed to utilize their existing production lines.
As a result, in the past month, a number of India’s auto makers have said they plan to go slow on commissioning new facilities. This is significant as investments in the auto sector typically take two-three years to come on-stream and so companies have to base capacity addition decisions and investments in anticipation of future demand.
“You will see adjustments in the capacities to be added,” says Rakesh Batra, a partner at the automotive practice at consultant Ernst and Young. It’s still wait-and-watch for most companies, he says, adding that no plans have been shelved.
Last week, Honda Siel announced that it had put on hold its plans to start producing as many as 60,000 cars at its second plant at Tapukara in Rajasthan. Renault Nissan will operate one shift at its Chennai facility instead of the two it had initially planned.
To be sure, India’s car market is expected to grow at a healthy pace in the long term and the industry’s present troubles are widely seen to be a temporary blip.
Car ownership usually accelerates significantly once a country crosses an income level of $5,000 (Rs2.35 lakh) per capita in purchasing power parity terms; India’s per capita income in 2007 was $2,753, according to World Bank 2007 data.
“At a 10% (car sales) growth rate, India needs about two plants coming up every year for the next 10 years,” says Vikas Sehgal, India director at consultant Booz and Co.
Still, in the past few months, high interest rates for vehicle financing and a slowing economy have resulted in many buyers delaying purchases of cars, trucks and two-wheelers. Sales have fallen for four of the last five months, according to Siam data.
The situation became particularly acute in November when commercial vehicle sales plunged 49.5%, the worst in some 10 years. Car sales were down 20%. The last time they fell this much was in November 2000.
Few expect a turnaround in December despite the government’s decision, earlier this month, to lower what is called centralized value added tax, part of excise duties, by 4%, and the industry is expected to shrink or at best post marginal growth this year.
Indeed, there are already signs. Commercial vehicle makers such as Tata Motors Ltd and Ashok Leyland Ltd have shut their facilities for several days in the last two months. Hyundai India, Mahindra Renault and Maruti Suzuki have either eliminated shifts or temporarily shut plants.
While this results in pruning inventory levels and costs, firms still have to pay employee salaries and interest and depreciation expenses on plant and equipment, which have added to margin pressure.
The financials of car makers could have been worse but for significant fall in prices, especially of steel, which typically makes for two-thirds by weight of a car, and aluminium.
One bright spot for some has been exports. Hyundai, for instance, says it has a natural hedge as exports have picked up the slack in domestic demand. It exported 175,800 cars in April-November, about 9% more than the 161,493 sold in India; in 2007 the exports were lower than domestic sales by 35%.