Why is the auto industry facing trouble?

Context

A lack of demand and financing has crippled the Indian auto sector forcing manufacturers to cut down production and jobs.

Background

• The automobile sector is one of the largest employers in the country, employing about 37 million people.
• The prolonged demand slowdown has triggered production as well as job cuts in the sector.
• July 2019 sales witnessed a drop of 18 per cent compared to July 2018
• Sales of passenger vehicles fell by 35 per cent in July 2019
• According to the Federation of Automobile Dealers Associations (FADA), the apex national body of automobile retail industry engaged in the sale, service and spares, the slowdown has caused over 2 lakh job cuts.

• Growth in the Automobile sector has been slow since 2000 in urban areas. The actual growth was coming from Tier I and Tier II cities (small urban towns).
• The automotive industry, which has about 50% share in manufacturing GDP, has been down for over six months due to reduction in demand. No doubt the ‘Make in India’ infused confidence in manufacturing but demonetization and GST dealt a severe blow to the economy especially the auto sector.The economic shocks due to GST and Demonetization have crashed the small town as well urban demands for the auto sector.

Causes of Auto Sector Crisis

• High Tax Rates: The collective taxes in auto sector in India are highest in the world. The current GST rate of 28% when added to the varying road tax (8-11%) makes the tax for entry level cars to about 38%.This has produced a dampening effect on demands for vehicles.
• Structural Transformation in the Macro-economy:Demonetization and GST have taken away the froth from the economy which is the unaccounted cash. No doubt it will serve the benefits to the economy in the longer run and will spur the growth butthe adjustment to these structural transformations is not without costs.
• Low Availability of Finance: Demonetizationhas choked the money supply in the market and it has a direct bearing on the demand for automobiles. Banks and NBFC are not willing to finance the automobiles.

• High Input Costs: The provisions of safety provisions in cars have led to increased costs. Moreover, the increased insurance rates and registration fees haveincreased the costs for the buyer and affected the small town markets.
• Distortion by Rental Cars: The availability of shared mobility car service has changed the behavior of the millennials in the urban areas.Some studies reveal that the mindsets of the millennialsnow prefer Ola or Uber or metro over to commit an EMI towards buying an automobile.
• Transition to BS VI Norms: The transition to BS-VI norms has significant costs for the diesel cars. There are no buyers for the second hand diesel cars and such cars are to be used for less time. Moreover, the price of petrol cars will also increase.
• Global Slowdown: This slowdown in auto sector is not unique to India but it is common in all the geographies. Auto-sector slowdown is a world phenomenon these days.

Impacts:

Impinges on the dream of making India a ‘manufacturing’ hub

• With the fall in demand and production in auto sector the manufacturing sector is staggering.
• India being thesixth largest automobile manufacturer in the world has barely 1% of global exports, and is largely absent from well-established global value chains.

Job Cuts:

• About 37 million job cuts
• Almost 80% of the workers employed in the automotive sector in the region are contractual
• The retrenched workers had compiled a charter of demands to their respective companies but these demands have not been addressed in a long time because of the slowdown. The layoffs and unmet demands have now led to protests in the region.
• Job cuts have increased the anxieties of the workers.

Impact on local economy: With the agricultural land of having been acquired by private builders, a vast majority of the villagers are now dependent on the migrant workers employed in the industrial units in the region. The shutting down of automobile units in different parts of the country forced the companies to shed off the contractual workers which rendered the migrant labourers from villagers jobless.

Impact on Ancillary Economy: The slump in automobile sales has hit foundries, steel, rubber and engineering processing industries which all cater to the automobile sector. The worst affected are the units that supply parts for heavy vehicles.

How to fix the problem?

Prime Minister through “Make in India", has the right idea when he says he wants to make India a global or regional manufacturing hub. But this cannot be accomplished by keeping an inefficient domestic industry shielded behind import barriers forever. Until something is done to change that, the industry will continue to lurch from crisis to crisis, and no lessons will have been learned.

Short-term measures

• Reduce GST rate: The Society of Indian Automobile Manufacturers (Siam), the automobile industry body, has been lobbying the Union government to reduce the goods and services (GST) tax rate applicable to automobiles from 28% to 18%.
• Reduce Road Tax:The central government must influence state governments to reduce road tax. It has been the tendency of state governments to hike road tax to strengthen their state exchequer.
• Retail Funding:RBI acknowledges that private consumption is the mainstay of aggregate demand.No doubt the banks and NBFCs have enough liquidity but the usage of high power magnifying glass in retail funding is going to hurt the economy.The liquidity must be converted into aggression or willingness to finance. FM, NirmalaSitharaman has also called for kick starting the finance movement. The sub-prime crisis of 2008 was also solved by kick starting the finance movement as retail financing is never risky.
• Reduce Import Tariffs: Crucially, unlike the automobile parts and commercial vehicle sectors, so-called completely built units —that is, finished passenger automobiles—have been characterized by very high import tariffs that are anywhere from 60% to as high as 125% in some cases, making India one of the highest import tariff jurisdictions in this sector among major economies. 
• Export Markets: While most auto companies are constantly cutting down production to reduce the inventory on factory premises and at dealerships, they are focusing on export markets to make up for the losses in the home market.

Long-Term Measures:

• Stable Policy Regime: Added input costs like high insurance rates, safety provision costs and upgradation to BS-IV norms need a stable policy regime. Our market is large enough to have the ecosystem where we have ICNGs and also the electric cars and both can learn, co-create and exist together. Hence, a stable policy regime is a must for reinvigorating dwindling auto sector.
• Liberalization of Labour Market: According to a 2016 research report by the World Bank, labour productivity in India in the automobile sector is only one-third of that in China, with correspondingly lower rates of productivity growth in India than in China over the years. Due to low productivity and an inefficiently low scale of production, in general, Indian automobiles are uncompetitive in the global market.
• Car Leasing: Car leasing is gaining popularity in India.As shared mobility has become an intrinsic part of urban mobility and a segment of buyers is staying away from owning cars, passenger vehicle manufacturers are seen investing in shared mobility and providing leasing options to attract buyers.

Challenges

This slump in auto sector is temporary and transitionary in nature and with a slew of measures the balance in the market will be restored. Some of the future challenges that Auto sector is facing are:

• The market share will be swept by electric cars in future and Indian auto-sector is not yet ready for that.
• The adoption of Bharat Stage VI will make the automobiles expensive and the industry should be ready to handle the future disruptions in the demand due to increasing prices.
• Protection of domestic auto industry by tariff barriers is not possible for longer run. The Auto industry must be competitive in the world and it must increase its exports as well the presence in the global value chains.

Way Forward

This requires the government should hold fast against industry lobbying, and move towards reducing import tariffs, as well as completing the country’s unfinished economic reform agenda, especially the liberalization of labour markets.