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Currently, the capacity utilization rate at factories has fallen to 63-68% against 80% in 2011, according to India Ratings and Research Pvt. Ltd. Photo: Abhijit Bhatlekar/Mint (Abhijit Bhatlekar/Mint)
Currently, the capacity utilization rate at factories has fallen to 63-68% against 80% in 2011, according to India Ratings and Research Pvt. Ltd. Photo: Abhijit Bhatlekar/Mint

(Abhijit Bhatlekar/Mint)

Auto industry: running out of gas?

The bad news has been piling up thick and fast, with automobile makers announcing production cutbacks to reduce inventory and the first signs of layoffs emerging as sales continue slide

New Delhi/Mumbai: Eicher Motors Ltd chairman S. Sandilya, president of the Society of Indian Automobile Manufacturers (Siam), was despondent on Friday, 12 July, as he spoke about the prospects of an industry that has seen sales decline year-on-year for eight months in a row.

Sales have fallen short of Siam’s forecasts for five quarters on the trot and Sandilya’s term as head of Siam, which started in September 2011, has coincided with the harshest downturn in at least 12 years for India’s automobile industry.

“There is not even a single positive factor," Sandilya, 65, said at a news conference in New Delhi. “The slow economic growth, high interest rates as well as fuel prices, and high inflation are all affecting consumer sentiment."

Sandilya concluded with an SOS for a government stimulus package of the sort that was rolled out in 2008, when cuts in excise taxes on scooters, motorcycles, cars and commercial vehicles to 8% from 10% helped the automobile industry overcome the fallout of the global financial meltdown that caused credit markets the world over to seize up.

“This time the problems are much more severe." Sandilya said.

Indeed, the bad news has been piling up thick and fast, with automobile makers announcing production cutbacks to reduce inventory and the first signs of layoffs emerging as sales continue to skid.

In the year ended 31 March, car sales in India declined 6.7% to 1.89 million units from 2.03 million in the previous year. It was the first yearly drop since 2000-01, when sales fell 7.73% from the previous year.

The decline deepened in the first quarter of the current financial year, with car sales falling by 10.4% against Siam’s expectations of an increase of up to 5%. In June alone, car sales fell 9% to 139,632 units.

The decline is more disheartening against the backdrop of increases of 8.93% in Brazil and 14.72% in China in passenger vehicle sales during January-May. Both emerging market economies are grouped along with India in the so-called BRICS groups, which also includes Russia and South Africa.

“We don’t see any silver lining," Pravin Shah, chief executive of the automotive sector at Mahindra and Mahindra Ltd (M&M), said after the company on Thursday, 11 July, announced that it would halt production at its factories for one-to-eight days in the remaining part of July to clear unsold inventory. The company, which makes the popular XUV500 and Scorpio sport utility vehicles (SUVs), reported a sales drop in May and June, its first in many years.

M&M has taken the step to balance production and demand, said Shah.

Economic growth that slowed to a decade’s low of 5% in the year ended March and interest rates that have remained high, despite three cuts of 25 basis points each by the Reserve Bank of India (RBI) since January, have hurt consumer sentiment in Asia’s third largest economy, forcing potential car buyers to postpone purchases. One basis point is one-hundredth of a percentage point.

To stimulate demand, some automakers have been offering finance at 0% interest and sweeteners such as free insurance. Volkswagen AG even offered the Vento sedan in exchange for an old car and 1, with the difference to be paid after a year, assuming the old car was worth half the price of the new Vento.

But the incentives haven’t succeeded and the automobile industry has started lowering its sights.

Onkar Nath, a 26-year-old marketing and communication executive at DuPont Co.’s India unit, has been thinking of replacing his car—an old-generation Alto 800cc hatchback from the stable of Maruti Suzuki India Ltd. He moved to DuPont with a pay hike recently, but wants to wait longer.

“I have been thinking of buying a new car for a year now and I will have to wait for a little bit more time… maybe December or January," Nath said. “There are two reasons...the lead time till December will allow me to settle in my new job and would also increase my savings for the car. On the other hand, I am hoping interest rates and fuel prices should come down by that time..."

The current despondency marks a dramatic change from January 2007, when India released the Automotive Mission Plan 2006-07, setting ambitious goals for the industry to reach in 10 years. At the time, the economy was growing at a rapid, near-9% annual clip and low interest rates and growing incomes were spurring Indians to purchase consumer durables with loans.

The vision of the Mission Plan was to turn India into a destination of choice for companies for the design and manufacture of automobiles and auto components with output reaching a level of $145 billion by 2016, accounting for more than 10% of gross domestic product (GDP) and providing additional employment to 25 million people. Sales were projected to increase to five million cars a year.

Siam has already written to the government that the industry will not be able to achieve the goals set under the mission and has asked for the deadline to be pushed to 2026; in effect, it conceded that the industry has been set back by at least 10 years.

Since the plan was conceived, the automobile industry’s contribution to GDP has increased by just half a percentage point to 6.5% and sales haven’t reached even half the target set for 2016.

At current growth levels, Siam expects a shortfall of 20-25%, or about $34 billion, in meeting the output target set for 2016. The industry needs to grow at a compounded annual growth rate of 16-18% to reach the target by 2016, which seems very unlikely now.

The capacity utilization rate at factories has fallen to 63-68% against 80% in 2011, said India Ratings and Research Pvt. Ltd, the Indian arm of international credit assessor Fitch Ratings.

The industry has also been hit by the rapid depreciation of the rupee, which has made imported components more expensive. In June alone, the rupee tumbled 4.9% against the US dollar, making it the worst performer among 78 global currencies, according to Bloomberg.

According to India Ratings, passenger vehicle volumes are unlikely to stage a meaningful recovery in the next six to 12 months. The rating agency has downgraded its outlook for the automobile sector, for the first time in six years, from “stable" to “stable-negative".

“The outlook reflects the structural weakness in the passenger vehicle segment in terms of high capacity additions and intensifying competition which may potentially become entrenched in the industry structure," India Ratings warned.

“This, amid weakening drivers of demand, does not portend well for such capital-intensive sector," India Ratings said in a 10 July note.

M&M said on Monday, 15 July, that it had laid off 500 temporary workers “due to the prevailing situation within the auto industry".

“We have not yet taken any call on delaying investments but if the current situation prevails we may have to," it said.

In July, MarutiSuzuki, India’s largest car maker, sacked as many as 450 contract workers from its car assembly plant in Gurgaon and its engine and transmission plant in Manesar—both located in the north Indian automotive belt. To be sure, the number is a small proportion of its contract workforce of 4,500 at the two plants, but it was the first sign of potential layoffs in the industry. Maruti also announced a reduction in the number of shifts from three to two at its diesel engine facility.

After growing 4.44% in the fiscal ended March, domestic sales at Maruti Suzuki have fallen 6.8% to 263,264 units in the first quarter of the current fiscal.

“A lot of things have changed—economic growth is not encouraging and inflation is still out of hand," said R.C. Bhargava, chairman of the Indian unit of Suzuki Motor Corp. “Also, the recent sharp decline in rupee has changed the views on currency for the year and that would mean higher fuel prices and that would increase the cost of operating a car."

According to Siam, the automobile industry lobby group, fuel costs rose 10% while vehicle costs were up 2% in fiscal 2013. India depends on imports to meet three-quarters of its fuel needs.

Other automakers are also taking measures to save on costs as the sales slowdown hurts. Toyota Kirloskar Motor Pvt. Ltd has decided to stop wage increments for workers, The Hindu Business Line newspaper reported on 29 June. Honda Cars India Ltd said cost-cutting was an ongoing process that had started during the recession of 2008.

P. Balendran, vice-president at General Motors India Pvt. Ltd (GM), said GM had cut production by 15% at its plants in Halol, in Gujarat, and Talegaon, in Maharashtra, for the last six months. GM, according to Balendran, has been operating at 45% capacity utilization level. The company’s installed capacity at both the plants is 282,000 units.

A Tata Motors Ltd spokesperson said the firm has been producing for six days a week for six to 12 months against the usual practice of seven days.

It’s not just the passenger car manufacturers, even the motorcycle makers have taken a hit.

“I don’t see any signs of revival," said Pawan Munjal, managing director and chief executive, Hero MotoCorp Ltd, India’s largest maker of two-wheelers, which posted a decline of 4.24% in sales during the April-June quarter from the year earlier.

“It would need a couple of big-bang announcements to turn around things," he said.

Maruti Suzuki’s Bhargava said the government has to take “some decisions to turn the tide in our favour".

Having promised to contain its fiscal deficit at 4.9% of GDP in the year to next March and confronting a shortfall in revenue as the economic downturn squeezes company profits, the government has very limited room to undertake stimulus measures of the 2008 kind.

The entire automobile industry ecosystem, including component makers and dealerships, are feeling the hurt.

“There are ripple effects as component makers have to adjust production as per the need of an OEM (original equipment manufacturer)," said Vinnie Mehta, executive director of the Auto Component Manufacturers Association.

There are no signs of revival for the next 15 months, said Nikunj Sanghi, a past president of the Federation of Automobile Dealers Association.

“The situation is much worse than in 2008-09," said Sanghi, who sells M&M utility vehicles and Hero MotoCorp’s motorcycles in the northern state of Rajasthan. “All of us have expanded network, infrastructure, which has pushed overheads. This is hitting us hard. Retail sales have plummeted and operating profit is going down."

Sanghi is counting on a stable government emerging from the general election due next year to set in motion strong economic measures that can boost economic growth—and with it, lift industry sales.

In December, Maruti Suzuki said growth in the domestic passenger vehicle industry may languish in the single digits for the next three years. Not only has the firm cut its forecast for the passenger car market to four million units by 2015-16, from its earlier projection of five million, but it’s also aiming to maintain the current market share of 40%, and not chase the 50% it once targeted.

Chairman Bhargava attributed the muted estimates for market growth on the lack of political will, which, he said, was preventing the government from undertaking so-called second-generation reform initiatives to revive growth.

Siam has maintained its forecast for growth in passenger sales this year at 5-7%, largely on expected interest rate cuts and expectations of faster economic growth, but few analysts see the target being met.

This financial year threatens to be another tough one for passenger vehicle makers, said Rakesh Batra, partner and national leader (automotive practice) at consulting firm Ernst and Young’s (EY’s) India unit.

Passenger vehicle sales are likely to dip by 3-5% in the year from last year, said Batra, and industry profits will likely be squeezed amid increasing costs and low capacity utilization. High discounts are likely to be necessary to push vehicle sales until there are fundamental signs of a recovery in demand.

“In the meantime, automakers and suppliers will need to adopt several cost-cutting measures and tighten working capital management," he said.

There is one silver lining, Batra said. The downturn provides an excellent opportunity for the industry to augment capabilities to be ready for the next cyclical upturn.

“In such an uncertain scenario, companies need to re-invent their value proposition to match changing customer demand and tune their internal organization engines toward higher flexibility, operational efficiency and effectively manage the capital agenda to remain competitive when the industry eventually returns to growth by FY15," he said.

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