Budget 2017: Modi govt can revive auto sector demand; 6 points to ponder

Updated: January 23, 2017 11:24:34 AM

The year 2016 looked like a year of turnaround. There was a feeling that this was going to be the beginning of a fairly long upturn.

carl-lThe year 2016 looked like a year of turnaround. There was a feeling that this was going to be the beginning of a fairly long upturn.

Kumar Kandaswami

The year 2016 looked like a year of turnaround. There was a feeling that this was going to be the beginning of a fairly long upturn. While 2016 itself was better than the previous years, there are fears of demand staying intact. Are these fears real? Let us look at some of the factors that may have an impact on automotive sector demand this year. The following factors have had a significant impact:

1. Net per capita disposable income growth (growth of per capita disposable income over growth of inflation);
2. Household savings;
3. Urban expansion;
4. Cost ownership that includes fuel and interest costs;
5. Corporate profitability and business growth;
6. Infrastructure build-out;
7. Rural cash flow.

The first four factors can be identified with personal vehicle purchase. The next two, while impacting personal purchase behaviour, also impact the demand for commercial vehicles. The last variable impacts entry-level motorcycles, mopeds and tractors.

In 2016, the policy action on diesel appeared to have had an impact on sales. In the segments that are big users of diesel powertrain, there has been a slippage in volumes. Undoubtedly, this may not be lost sales, as some of the demand would have gone to gasoline vehicles anyway.

The other government action of demonetisation appears to be playing out in ways that were not expected. It also looks like an issue that will stay with us for a while, both in reality and in the minds of potential buyers of automobiles.

Urban personal vehicles

A quick look at sales numbers of last year suggest the variables impacting personal purchase seemed favourable. The impact of demonetisation, beyond the immediate panic reaction, looks like a variable that may not have a lasting impact in case of salaried car buyers. Here is the reason: The extent of credit that gets into both passenger cars and two-wheelers is significant. Therefore, they are ‘clean’ transactions and the entire supply chain transacts through formal channels. This suggests the direct impact will be marginal.

Rural personal vehicles

The segments that can get impacted would be rural two-wheelers and used vehicles. Even in used vehicles, only the second change transactions happen outside of the formal used vehicle networks. Sale of parts through retail may be impacted significantly.

The period of time for which demonetisation will impact the segments that are not natural candidates to suffer such an impact is not yet clear.

MSME buyers

The uncertainties that demonetisation causes to the segment of buyers that are dependent on trading, services and small business in general will make them postpone their buying decisions. This is likely for two reasons: The fear of penal action (whether real or assumed) and the loss of business or slowdown in cash flow, even if for a short period of time. While they may settle down this year, the sentiment is likely to stay down, resulting in slow growth of categories like small cars and two-wheelers. Small cargo carriers and three-wheelers could be the other categories that will get impacted.

Luxury cars

Interestingly, the top-end of the passenger car sales may slow as a small part of that segment will not want to draw attention to themselves, from the fear of action by tax authorities. It is not to say that they have done anything wrong, but they are likely to feel that it is prudent to lie low. With the increasing number of finds of hidden cash over the months, there is probably going to be the fear of increased action by the taxman.

Informal players

There is likely to be a shift of business from informal players to formal networks. The neighbourhood used-car dealer may be in danger of extinction. As would informal parts dealer. This is likely to be further accelerated by the implementation of GST this year.

A combination of reduced cash transactions and requirement to be GST-compliant will force business to shift to formal networks. Anecdotally, there are signs of this across segment, even if outside the auto sector.

The larger question is: How long will it take for the economy to reorient itself to the new reality of transacting through formal channels? That would determine the speed at which the vulnerable segments highlighted above go back to the natural levels of buying, driven largely by economic considerations. What this means is that the benefits of favourable demand drivers, like low inflation, interest rates and fuel costs, will be somewhat lost. This is more to do with people’s perception than reality. And that is not easily controlled, unless the upcoming Union Budget has a trigger for increased buying of passenger or commercial vehicles and changes the market sentiment significantly.

Govt to revive demand

In a situation like this, it is important to have the government facilitate demand. This can happen through both financial and non-financial methods. First, it is important to speed up the plan to implement urban bus corridors and have demand created through urban infrastructure initiatives. Second, tightening and implementing retirement norms for vehicles can support demand creation. Third, strengthening the framework by which the vehicle aggregation models flourish would enhance consumption in that segment. Demand could also be enhanced by building adequate road infrastructure, particularly in urban areas. Some of these can be accomplished in quick time.

The author is partner, Deloitte Touche Tohmatsu India LLP

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