A review of Indias automotive industry - Management briefing

Political and economic overview

India has shown a steady gross domestic product (GDP) growth in the past few years. In 2004,
three countries – China, USA and India – accounted for over half of world growth, according to
the IMF’s purchasing power estimates. In 2005-2006, the Indian GDP grew 8.6% including
manufacturing sector growing 8.1%. In 2006-2007, a mild moderation in GDP growth to around
7%is expected, based on rising cost of energy and raw materials. This growth is impressive in
itself and does not reflect a slow-down in the economy’s longterm growth momentum.

Deregulation, reform and economic growth

The current government has undertaken an economic policy based on a buoyant economy.
While the 2006-2007 Union Budget aims not to hinder the growth of the economy, it focuses on
developments in the social sector, a reduction in customs duties and a move for fiscal
consolidation with a fiscal deficit target of 3.8%.

Infrastructure development – ports, roads and airports, power

The nation’s infrastructure is highly underdeveloped. The basic national infrastructure –
including road network, power, ports and airports – are all operating over capacity and are
unable to meet the growing demand. There is a great need for expansion of these utilities to
meet demand, which is growing at a much faster rate than the ramp up. All the budgets in
recent years have included infrastructure as a priority but progress has been slow. This budget
was no different but additionally spoke about innovation, expansion of capabilities and
restructuring of the infrastructure programmes to meet the complex challenges faced by them.
State-level power sector reforms were set in motion, based on the successful model of VAT
implementation, though no financial incentives or financial commitments were announced.

Road transportation
India’s road network is hindering its growth. National highways account for only about 2% of
the total road network, but carry nearly 40% of the total traffic volume across the country. The
sparse network especially hinders the manufacturing sector, which must transport its goods to
the market or ports for exports. The importance of having the “right” road infrastructure is
critical, given that Indian roads carry about 70% of cargo traffic and 85% of passenger traffic.
The government set out to build the road network through its ambitious NHDP (National
Highway Development Programme) project: ○ Phase I consists of the 5,846km long Golden
Quadrilateral project, which connects the four metros (Chennai, Delhi, Kolkata and Mumbai); it
was scheduled to complete by June 2006 but is expected to overrun to the year-end. ○ Phase II
comprises the North-South and East-West Corridors, roads stretching a distance of 7,300km
connecting the four corners of the country. ○ Phase III involves the four-laning of over
10,000km of the existing road network. Beyond these phases, projects will be undertaken to
streamline traffic flow and widen the highways, etc. However, the project is mired by delays.
The biggest challenge is in acquiring land for widening or making new roads. In 2005, no land
was acquired in the states of Maharashtra, Kerala, Haryana and Punjab. Financial support and
capacity expansion has been enhanced in the latest budget for the NHDP to increase the
momentum of the project.

Airports
The Indian air travel sector underwent a transformation with the entry of lowcost carriers. This
has brought air travel to the masses but the overcapacity of Indian airports is resulting in
delays and choking its growth. Growing overseas travel is hindered by lack of airport
infrastructure. For this reason, the government has tendered out airport modernisation
programmes to private consortiums after years of dilly-dallying since the initiation of the
programme. Plans are also afoot to build new airports in large cities and expand mediumsized
city airports.
Sea ports
The economy in general, and specific sectors such as automotive components, base future
growth to a significant extent on exports. Of the goods exported, 90% are handled by the Indian
ports. But due to a lack of investment to enhance port capacities, 12 major ports are operating
close to capacity, causing delays and resulting in some of the slowest turn-around
times. Moves to expand capacity must keep up with export growth to ensure the global market
opportunity is not derailed. A transportation delay adds to production costs, which
manufacturers have to factor in when making quotes. With a large coastline of 7,517km, India
has the potential to establish strategically located ports. The port development is being carried
out under the auspices of the National Maritime Development Programme, which is handling
101 projects. In addition, the establishment of a new deep-draft port in West Bengal was
announced in the budget.

Power
In spite of a continuous increase in the volume of power generation in India, the country is
grossly power-deficient. Country’s State Electricity Boards face high levels of aggregate
technical and commercial losses and net losses, even after subsidies. Due to the poor
performance of the boards, which are plagued by skewed tariffs, poor transmission and
distribution, and insufficient power supply from the powerplants, the country suffers power
outages even as the demand steeply climbs. Power consumption is expected to grow
exponentially in the medium- and long-term, hence a reform in the sector was initiated as
apriority. In 2003, the Electricity Act was passed, along with various positive measures which
bear significant long-term implications. The Act has opened up the power sector to private
entrepreneurs in power generation, transmission and distribution, bill collection and free
trading of surplus power. Some private players have started to participate in the sector, as the
continuing deregulations make power an increasingly attractive industry to enter. While the
ball has been set rolling for public-private partnerships in infrastructure development, its
success depends on the government’s ability to attract private capital and foreign direct
investment (FDI) in a sustained manner. The budget includes tax rebates for infrastructure
projects, but has done little to address critical issues, such as setting up a framework to
determine the commercial viability of infrastructure projects and establishment of regulatory
authorities for ensuring a level playing field and transparency ininfrastructure sectors.

Social sector focus

The recent Union Budget made reform of the social sector a high priority. The government has
increased resource commitments for the sector and consolidated various ongoing projects and
schemes into eight structured programmes. The restructuring is aimed at increasing the chance
of success, since these objectives are usually interdependent and complementary. The budget
has set a fast-track funding process for social welfare initiatives with an increase in funding by
43% over the previous year. Further, privatisation of public sector units (PSUs), which began a
few years earlier, was put on hold and PSUs asked to increase productivity. If performance of
these units is improved without privatisation, the government feels there is no immediate need
to divest them.

Stock markets have climbed

The Indian stock markets have witnessed a significant growth in recent times. The index,
Sensex, has doubled to over 12,000 points within two years. The Sensex surged, with the
basket of stocks in the index appreciating because they were said to be highly undervalued
based on growth in India. But, the rise came both horizontally, across sectors, and vertically,
across small and large capitalised stocks. With the economy performing well on various fronts,
stocks of companies in sectors such as engineering, automotive, commodities, FMCG and
services have appreciated across the range. Foreign institutional investors (FIIs), which are
mostly asset management Companies based out of tax havens, are among the main drivers of
the Indian
stock market. In the recent years, the FIIs enrolment has grown in numbers making the
investments made by them in the Indian stock markets surge. Recently, highly conservative
investors like pension funds and FII’s from Japan and the Middle East have also joined the
group. A major attraction for the FIIs is that they are not taxed in the country as are the Indian
stock traders, due to the double taxation treaty with foreign countries. In 2005 alone, FII
investment crossed US$10bn taking their cumulative investments to over US$30.3bn. In 2006,
the stock market is expected to reduce its momentum as earning of companies get squeezed on
rising costs. But in the medium- and long-term, the market has a huge growth potential based
on Indian companies achieving global scale and supplying products worldwide, based on low
costs and high technology and quality.

Fiscal deficit a worry

The government has steadily reduced its fiscal deficit from about 10% in 2001- 2002 to 8.3% in
2004-2005, and budgeted to decline to 7.6% of GDP in 2005- 2006. However, the 3.8% target for
2006-2007 appears ambitious and likely to be missed as corporate earnings are expected to
slow down on squeezed profit margins. But, in general, the healthy macroeconomic
environment looks steady for now and in the medium term.

Inflation, interest and exchange rates

In 2006, the risk of inflation remains, based on high global crude prices. Corporates are being
forced to raise the prices of their products to offset the rise in the cost of oil, which will be
offset by some initiatives on indirect taxes to keep inflation under 5% for the year. In 2005, the
reverse repo rate was hardened by 75 basis points to 5.25% over three adjustments in April and
July 2005 and January 2006. The latest rate hike was a pre-emptive measure to control future
inflationary expectations and to ensure quality of credit. This manifested itself by banks raising
loan and deposit rates. In 2005, the average exchange rate declined to US$1 = INR44.26, down
from INR45.05 in 2004. The rupee was forced down by the mounting trade deficit on oil
imports, while the steady inflow of foreign exchange into the capital markets and a
depreciating US dollar supported the upward trend in the value of the rupee. In early 2006
however, the US dollar appreciated slightly, and during 2006, the rupee is expected to
fluctuate in the INR44-45 range, based on easing of the FII limit in the capital markets.

A number of issues may affect industry growth

Indian industry is often affected, albeit temporarily, by small factors which may be
insignificant – or may not even exist – in other countries. The fact that the present government
stays in power, helped by the outside support of the communist parties, is a factor that may
affect industry now and then. Also, a number of political parties have been demanding that the
private sector should give more jobs to certain sections of society which have not developed at
the same pace. This may also lead to resentment in the industry, and, in extreme cases, may
result in shifting of some industrial units to other states.

Increase in financing spurs consumption

The recent growth in car sales has, to some extent, been driven by financing options which are
now available liberally. The easy car financing options mean that customers have often been
more concerned with equated monthly instalments (EMIs) and not the actual car price. This has
acted as a catalyst for car sales, especially those of expensive cars. However interest rates
have now started moving up and the interest burden may act as a dampener for car sales
growth.

Small cars get a boost through excise duty reductions

In the budget, the finance minister announced a reduction in excise duty on small cars. This is
likely to result in an accelerated growth of the number of small cars in India. According to the
government, small cars are defined as: ○ cars smaller than 4.0 metres in length ○ cars powered
by either gasoline engines smaller than 1.2 litres or diesel engines smaller than 1.5 litresThe
reduction in excise duty will be applicable only on cars which fulfil both criteria. Excise duty
will be reduced from the current 24% to 16% on these cars.
GDP growth target of 8-10%
In 2005, India’s GDP grew at a little under 8%. Now the government is targeting a GDP growth
of 8-10% in order to accelerate the development of the country. This target will be met
through high industrial growth, supported by strong agricultural growth. The government plans
to support it through increasing the rate of infrastructure growth. With the accelerated growth
of the economy, car demand is expected to increase in the future.
Focus on agri sector unlocks huge market potentialIndian car sales have always been centred in
major cities. For example, Delhi has more cars than many of the large states combined. Now,
with agricultural output increasing and car prices coming down, an ideal situation exists that
may result in increasing demand for cars in the interior of the country. A large percentage of
the population is still dependent on agriculture for its livelihood. With a stronger growth in
agricultural output, the demand for lifestyle goods – including cars – will increase in the future.
Also, with the government’s strong emphasis on infrastructure development – including interior
roads – demands from the interior is likely to accelerate further growth. The manufacturers
acknowledge the hidden potential in the interiors and are spreading their sales and service
networks to small towns. However barring Maruti and, to some extent, Tata Motors and
Mahindra, most manufacturers still have very limited networks.

Contents of review of Indias automotive industry - Management briefing :

India at a glance
Changing demographics
Consumer retail
The latent rural sector
India’s SWOT analysis
Strengths.
Weakness
Opportunities
Threats
Political and economic overview
Infrastructure development
Deregulation and reforms
Economic growth picks up
Stock markets are booming
Government borrowing has been a worry
Political timetable has slowed fiscal reforms
Duty and taxation remain a concern
The top three issues affecting industrial growth in India

The light vehicle market in India

Low penetration means huge opportunity
Passenger car penetration – How car manufacturers fare
Passenger vehicle market boosted by strong economy
India’s ‘Big Three’ focus on affordable small cars
Market segmentation
Segments B and C to see further growth
Quadricycles have hit a roadblock
Tata Motors still working on the INR100,000 car for everyman?
Luxury segment seeing growth from a low base
GM looks to exploit GMDAT connection in India
Maruti cuts prices, makes the Alto its cash cow and the new Swift a star
Low cost still remains a high priority

Light vehicle manufacturing industry

The era of licenses
The Maruti era
Government policy towards auto industry sees FDI constraints fully lifted
Vehicle exports seeing sharp growth
Maruti 800’s long-term future uncertain
Tata Motors fills out Indica platform-based product range
Hyundai chooses India as global small car hub – Santro sales boom
Mahindra & Mahindra enjoys Scorpio success. Looks at Renault and the Logan
Ford shows added commitment to India
Hindustan Motors’ Ambassador is still there
Capacity expansion seen across the industry

Components industry
India looks to freer trade to develop industry further
India’s strong skill base
Companies open up customer support centres in India
Suppliers gain competence on a global stage
Multinational suppliers provide the latest technology