Clearly, the most violent fall in the auto index was visible post August 2018 when the IL&FS crisis came out in the open and the financing by NBFCs took a real hit, This was the period when auto sector actually started to underperform. Here are the factors that conspired.
Rural and semi urban demand has taken a hit
The one segment that the auto sector has been relying on for future growth was the fast growing rural and semi urban segment. It had all the makings of high growth. The government had announced assured MSP at 150% of cost to farmers and invested heavily in enhancing rural infrastructure including rural roads. In addition, a slew of social security measures like the free health insurance scheme were supposed to boost rural demand. Nothing of that kind really happened. Instead, what the elections in Gujarat, Karnataka, MP and Rajasthan showed is that rural distress and rural angst was at its highest level. That was hardly a recipe for growth in auto demand. In addition, the below average monsoon in 2018 as well as the floods in Kerala badly dented rural and semi-urban sentiments for autos.
Higher fuel prices did matter a lot
Prices of petrol shot up last year from Rs75/litre to Rs92/litre on the back of a sharp spike in prices of Brent crude. At $85/bbl, the government had little choice but to pass on the costs to the consumers. India has traditionally been a price sensitive market when it comes to cost of vehicle maintenance. The big boom in auto started when diesel cars were introduced promising economy and performance. The latest consumer survey by Credit Suisse has clearly pointed out that in the last one year the propensity of the Indian consumer to postpone purchases of consumer durables had doubled. When customers wait and watch, it is the dealer inventory that gets piled up; which is what we have been seeing in the last few months.
Funding costs have actually made a big difference
If you look at the chart of auto stocks, the sharpest crash in auto stock prices came in the post August 2018 period. This was a tipping point. Kerala state had just been ravaged by floods, oil prices had started to rise and IL&FS had declared its first default on its debt commitment. Over the next few months, IL&FS gradually imploded but the impact was much bigger on the financial markets. NBFCs which were relying on the short term market to raise funds suddenly found funding taps drying up. With NBFCs in a bind, funding for automobiles almost came to a halt. In addition, the rise in bond yields on inflation fears, led to funding costs creeping up between 125 to 200 basis points. That almost changed the economics of buying and owning a vehicle and was a key reason for the slowdown in the auto sector.
Above all, there is a structural shift
- A correction of 27% in a year is rarely a one-off occurrence; especially when the overall index was up during the same period. It is normally suggestive of structural shifts in the industry. There are 3 shifts that are happening right now.
- There is a shift out of diesel for economic and environmental reasons. That could show up in auto product portfolios.
- Auto companies are seriously looking at futuristic cars powered by batteries. While estimates are conservative, these shifts rarely happen gradually.
- Indian consumers are increasingly shifting to use-and-pay model for cars. That trend is popular the world over and is catching up in India. That could have bigger implications for auto demand in the coming years.