Economic slowdown

Signs of a crisis in the automobile industry

Print edition : September 13, 2019

At a Mahindra & Mahindra Ltd factory in Chakan, Maharashtra. A file photograph. Photo: Kuni Takahashi/Bloomberg

Finance Minister Nirmala Sitharaman at a press conference in New Delhi on August 23, where she announced a slew of measures to address concerns about the economy. Photo: Sandeep Saxena

At a TVS Motor Company facility in Hosur. Photo: S.R. Raghunathan

At a Daimler India Commercial Vehicles factory in Chennai. A file photograph. Photo: Bernd von Jutrczenka/Picture Alliance via Getty Images

The Narendra Modi government’s response to the Indian automobile industry’s worst slump in two decades reflects an inability to recognise the slowdown as a symptom of a much bigger crisis in the economy.

The wheels are coming off the Indian automobile industry, the shiny poster boy for economic reforms since economic liberalisation began in 1991. The incessant slide in sales in automobiles of every conceivable kind—from commercial and passenger vehicles to the humble two-wheeled moped that is ubiquitous across rural and semi-rural India—during the last year has rocked the industry like never before. All the major players, many of them household names, have ramped down production in the wake of the crisis. Naturally, as a result, the large and diverse ecosystem of component makers has been affected too. Many smaller units that have acquired a reputation as suppliers of equipment to automobile manufacturers have also been hit hard. Estimates of job losses range widely, with some projecting losses of more than three lakh jobs. These job losses include those in the main vehicle manufacturing units, the ancillary supply industries, and in dealerships which also provide services to customers.

The industry is crucial because it accounts for about 7 per cent of national gross domestic product, over one-fourth of the GDP emanating from the industrial sector, and a whopping 49 per cent of all value of goods and services in manufacturing activity. Thus, the sharpest slowdown in several decades could either be treated as an ominous indicator of a much wider malaise in the economy, or simply as a localised illness. The spate of announcements by Union Finance Minister Nirmala Sitharaman on August 23 appears to indicate that the Narendra Modi government chooses to see the automobile industry crisis as a sectoral one. As the industry hopes for a recovery in the festive season that is round the corner, it remains to be seen whether the band-aid approach will work on a deeply wounded economy.

Job losses across the industry

The industry, which, according to its chief lobbying arm that represents key manufacturers, the Society of Indian Automobile Manufacturers (SIAM), employs directly and indirectly close to 30 million Indian workers, is now shedding jobs rapidly across the country. It is likely that much more than three lakh jobs have been lost already in the slowdown. Under the not-so-watchful eyes of successive governments that have allowed the industry to casualise its workforce—a recent study by State Bank of India estimates that 70 per cent of the workforce in the automobile component industry is employed on a contractual basis—it is quite possible that significantly more job losses are happening under the radar of public scrutiny. The study observes that a 15-20 per cent reduction in output in the components segment could result in job losses of a similar order of magnitude. It observes that the overall automobile sector, which was generally projected to yield 25 lakh jobs incrementally on an annual basis, has already shed about 10-15 per cent of its workforce.

The media’s attention was caught when large players announced production halts at their facilities across the country. In the passenger and commercial vehicles segment, manufacturers such as Tata Motors, Mahindra and Mahindra, Maruti Suzuki, Toyota and Ashok Leyland have announced no-production days. While Tata Motors shut its Jamshedpur facility for at least three days in August, Ashok Leyland, the commercial vehicle manufacturer, shut some of its facilities for nine days in the last couple of months. Component suppliers from the Chennai-based TVS Group have also shut their plants for a few days because of the slowdown, and the country’s largest producer of two-wheelers, Hero MotoCorp, has shut production for four days at five of its plants. While Mahindra and Mahindra has announced that it will shut production for 14 days in the July-September period, Maruti Suzuki and Toyota have announced shutdowns for three days and eight days, respectively. With dealers saddled with inventories running into several weeks, component makers such as Bosch have been forced to shut down for 10 days, Jamna Auto for 20 days, and Wabco for 19 days.

Job losses at dealerships are estimated at a whopping two lakh across the country. The burden of high inventories is obviously being loaded on to all classes of employees—sales executives, service technicians and workers—as dealers scale down operations or exit altogether, as many have done. According to a research note by ICICI Securities released on August 19, while inventory levels of passenger vehicles have improved marginally from 40-45 days of sales in April 2019 to 25-30 days in July 2019, the situation has worsened for dealers of commercial vehicles and two-wheelers. Inventory levels for commercial vehicles have increased from 45-50 days to 55-60 days; unsold stocks of two-wheelers at dealers’ premises have increased from 45-50 days in April to 60-65 days in July. This is significant because while passenger vehicles have more visibility, the commercial vehicle segment is a much better barometer of the economic prospects for the industry by virtue of having an immediate and direct connection to the wider economy. Two-wheeler sales are an important indicator of the lower end of the market that is vulnerable to wage and income movements that have an important bearing on demand.

The captains of the automobile industry deftly played the jobs card when they met the Finance Minister on August 7: they sought “relief” in the form of a stimulus for the industry. On their wish list were the usual suspects: reduction of the goods and service tax (GST) on vehicles, which the Finance Minister had hiked to 28 per cent in her latest Budget; and a relaxation of liquidity and easing of credit for automobile retailers. Yet, when Nirmala Sitharaman unveiled a sentiment-booster package on August 23, there was little cheer for the prime victims of the crisis, the workers. Instead, the contents of the Finance Minister’s motley package was a mishmash—some more capital for the banks (Rs.70,000 crore, which had been anyway committed earlier); the removal of surcharge on foreign portfolio investors, which would result in the government losing a princely sum of Rs.1,400 crore; and a slew of announcements and “clarifications” of earlier announcements, that are obviously aimed at lifting sentiment rather than making a substantive difference. Among the measures were an enhanced rate of depreciation that eligible entities can claim on vehicles purchased until March 2020; an assurance that Bharat Stage IV vehicles bought until March 2020 would remain valid for the lifetime of the registration; and the withdrawal of a ban on vehicle purchases by government departments. Although industry leaders—as industry leaders often do—have generally welcomed the move as likely to boost sentiment in the run-up to the critical festive season, there is reason to suppose that being sentimental would be utterly wrong. To understand why things could remain sombre for the industry for a longer period than its captains are letting on, one has to turn to the very nature of the automobile industry and its role in the wider context of the economy.

Crisis in the wider economy

A report published in July 2019 by Edelweiss Securities Ltd, “Automobiles: This time it is different”, makes the significant observation that this slowdown is fundamentally different from all similar episodes in the last two decades (see Table 2). It points out that unlike the four previous episodes since 1998, this, the fifth one, has not been triggered by adverse global developments. The slowdown of 1998 was sparked off by the Asian financial crisis; the episode of 2001 was triggered by the bursting of what is popularly known as the Dotcom Bubble; the slowdown of 2008-09 was set off by the global financial crisis; and the episode of 2012-13 was caused by the sharp depreciation of the Indian rupee, which significantly added to costs of automobile and component manufacturers. This time the big bad world is not anywhere in the picture; simply put, we are to blame for our own woes.

Indeed, that is exactly what Rajiv Bajaj, managing director of Bajaj Auto, said a day before the Finance Minister unveiled her “stimulus” package. “Most of the automobile slowdown is the industry’s own making,” he told a TV channel. He pointed out that a 5-7 per cent drop in two-wheeler sales should not be described as a crisis and asked companies not to indulge in “fear mongering”. He asked companies not to make much of wage costs because they account for a mere 4 per cent of the turnover. Instead, he urged companies to look within and realise that they were producing “mediocre” products that could not hope to compete in the global market. “When you make scooters and bikes and cars and jeeps and SUVs and trucks and buses and everything under the sun, you are obviously not going to be world-class at anything,” Bajaj remarked. Bajaj had earlier said that his company was geared to moving towards the electric vehicle (EV) platform in order to be ready well before the 2025 deadline set by the government for allowing only EVs in the two-wheeler segment. He said his company would be ready with its first offerings by 2022.

As the current crisis—which has been on for about a year—unfolded, industry chiefs chose to focus on what appeared to be their immediate “pain points”. Thus, they blamed the revised pollution control norms, the BS VI, which would not only increase costs but result in customers delaying purchases. Then, after Nirmala Sitharaman raised the GST on vehicles to 28 per cent, this was cited as the cause of the slowdown. Of course, the problems of the “liquidity crisis” in the NBFC segment and the banks’ unwillingness or inability to lend were cited as factors that worsened the crisis (see “NBFC crisis”, page 22). In simple terms, industry chieftains were both unwilling to accept that their problems could either be within or that the happenings in the wider world around them were having an impact on their fortunes. Only an abiding unwillingness—or the inability—to appreciate that an industry that is so closely enmeshed with the economy cannot forever escape the effects of a wider slowdown can explain this head-in-the-sand attitude.

It is true that the auto industry contributes greatly to the wider economy, but none can dispute that the wider economy around it is also organically linked to it. Take the case of bank credit and interest rates. The successive lowering of the policy rate, aided by a central bank leadership that is apparently in tune with the Modi regime’s needs, has had virtually no impact on credit disbursements. According to a recent report (August 14, 2019) authored by Soumya Kanti Ghosh, Chief Economic Adviser to the State Bank of India Group, “Bank credit is the effect and not the cause of the slowdown.” He points out that in the three-year period ending 2018-19, incremental bank credit to the overall economy was about Rs.20.3 lakh crore; yet the GDP increased by just Rs.36.5 lakh crore, a poor loan-return ratio. Ghosh also points out that industry’s share of the incremental borrowing was just Rs.1.5 lakh crore, a measly 7.4 per cent. “Segments of retail loans like vehicles have indeed registered negative growth, revealing a clear lack of demand and other cyclical issues afflicting the auto sector,” he remarked. Clearly, conveniently blaming banks, especially those in the public sector, will not do. Similarly, although there may be liquidity shortfalls in pockets of the economy, the repeated cries of a so-called liquidity crisis masks the looming threat of fresh defaults (potential insolvencies), now concentrated in the non-banking financial companies (NBFC) segment (the banks having been the earlier victims). It is evident that the spectre of a liquidity crisis is being raised in the hope of sparking off another round of inflating a bubble in order to get over an immediate crisis in demand.

Ghosh asserts that the “slowdown in demand is a fact”. The “misplaced consensus that banks are not extending enough credit to help us navigate through the current slowdown” is responsible for shifting attention from the crisis in demand, Ghosh remarked. Describing this as “a false narrative”, he explains that although economic theory suggests a bi-directional causality between economic growth and credit off-take, a “slowdown will percolate into a credit slowdown and not vice-versa”. In Ghosh’s rendering, therefore, the paltry offtake of credit is symptomatic of faltering demand, not a cause of the crisis. Additionally, the pace of growth of wages and incomes has a direct bearing on demand. The slackening pace of growth of rural wages has been well documented. Ghosh reveals in his report a similar slack in corporate sector wages since 2016. Clearly, when incomes are on a leash, consumers cut consumption. Indeed, there is now widespread anecdotal evidence that the Indian situation has worsened from “jobless growth” to one that can only be described as “jobless plus growthless”.

According to a private market research database, during the first five years of the Modi regime, the net sales of 2,769 companies increased by 34.5 per cent. During this period net profits increased by 20.5 per cent—an average annual increase of 4.1 per cent—lower than the inflation rate. Critically, the value of assets increased by a measly 3.5 per cent over these five years. This also corroborates the widely accepted consensus that investments have been stagnant in the Indian economy, which explains why corporates are in no hurry to borrow even if the interest rates are coming down. This is also happening because companies, heavily saddled by a debt overhang, are shedding debt, termed deleveraging in the language of the bourses. And, as Puja Mehra pointed out in The Hindu (August 22, 2019), the collapse of aggregate investments by a whopping 60 per cent in 2016-17 after the demonetisation misadventure is yet another reason why the Modi-era GDP numbers are suspect.

Vehicle manufacturers’ contention that the new emission norms, enhanced safety features, higher GST, insurance costs and several other factors have deterred fresh purchases only partially explains the slide in sales. Indeed, the increase in vehicle cost in order to meet the new emission norms is substantial only in the case of two-wheelers, and to some extent in the case of passenger vehicles (passenger vehicles running on diesel would cost significantly more). Instead, the Edelweiss report cited earlier points out that used car sales have consistently outpaced new passenger vehicle sales; sales of used cars have grown at an annual compounded rate of 10 per cent, significantly higher than that of new vehicles. The report suggests that price-conscious consumers may be shifting over to used cars, especially when faced with higher cost of vehicles.

Blaming the emission norms for the slack in the commercial vehicle space is clearly illogical, as the Edelweiss study demonstrates. On the basis of an analysis of costs, it shows the higher cost of the vehicle can be recouped through a freight tariff hike of about 2.5 per cent, which would be offset by better fuel efficiency. An improvement in the fuel economy by 5-6 per cent would eliminate even the necessity of a freight tariff hike, it observed.

Speaking to Frontline, G.S. Ramesh, a veteran in the automobile industry, who as a senior executive with Hyundai helped it launch operations in 1997, said the Indian automobile industry was going through a churn. Ramesh, who founded the Chennai-based consultancy Layam Group in 2007, which has among its clientele several top Indian automobile brands, says the Indian automobile industry was approaching a “tipping point” as it prepared for the transformation from liquid fuel-driven mechanical to motor-driven vehicles using electric power.

The transition from conventional engines to EVs would require a completely different approach to vehicle manufacturing. For instance, the gearbox is not needed in an electric vehicle. This requires companies to enhance their capabilities in order to move to a different platform. Meanwhile, an ecosystem would need to be prepared—better batteries, charging points and other facilities that encourage EVs. Ramesh sees the ongoing crisis as a “wake-up call” for the industry. He believes that although the industry might breathe a “sigh of relief” over the Finance Minister’s sops, it would be foolhardy to see them “as anything more than a temporary solution that enables the industry to clear the inventory that has mounted in the last few months”.

How to spot an oncoming recession is a question that has vexed economists. This is primarily because most episodes of recession are designated as such only after the event. Several years ago, Alan Greenspan, former Chairman of the United States Federal Reserve, suggested the use of data on men’s underpants as an indicator of a looming slowdown. His reasoning was that when men stopped spending on an utmost necessity such as underpants, something was seriously wrong. Well, the latest data on the sales of underpants, and the performance of the companies making them, do not bear good tidings. Of the four companies making innerwear, two reported a sharp decline in sales and one reported flat sales, while the market leader registered a tepid growth of 2 per cent, its worst performance in more than a decade.

If the sales of commodities ranging from biscuits to banians (vests) are plummeting, can the princely automobile sector expect to be spared?