Thanks to the low base in the October-December quarter of 2008, auto firms are likely to report unusually strong growth in profit in the third quarter of this fiscal. Even volume growth for December will be the highest in recent times because of the low base of December 2008. In terms of news flow, therefore, the going is likely to be rather good for auto makers in the near term.

But what could be missed is the fact that margins are coming under pressure. For most auto firms, margins peaked in the September quarter, thanks to relatively low raw material costs and the positive impact of the stimulus package. But low-cost inventory has been running out and commodity prices have risen from their lows.

But pressure on costs is not only because of rising commodity prices. All four-wheelers have to meet new emission standards from next year, which too entails higher costs.

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IIFL Capital Pte Ltd’s Jatin Chawla makes an interesting point in a recent note to clients: “With changes in emission norms around the corner, prices of four-wheelers are set to increase by around 4-6% to account for the shift to better technology. Given the state of government finances, excise duties are also likely to be increased (by 2-4%, in our view) in the FY11 budget. Thus, vehicle prices are anyway set for a 6-10% increase and it will be difficult to pass on any further hikes to compensate for the increase in raw material prices, especially for CV (commercial vehicle) manufacturers."

Reducing excise duties had been part of the stimulus package and now that auto sales are buoyant, the reductions are likely to get reversed. If this happens, firms would have to hike prices. Consumers may not be willing to absorb so many price hikes in quick succession, which may cause firms to go slow in passing on increases in cost, putting pressure on margins.

Graphics by Ahmed Raza Khan / Mint

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