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Domestic auto market not in pink of health

Domestic auto market not in pink of health

As India's ambition to become a global auto hub is curbed, manufacturers focus on the domestic market. But that is where the turmoil is.

R.C. Bhargava, chairman, Maruti Suzuki R.C. Bhargava, chairman, Maruti Suzuki
R.C. Bhargava breaks eye contact, looks at the blank white wall to his right and shakes his head: "I don't know," he says. Tall, lean and ramrod straight at 76, Bhargava is not easily fazed. A 1956-batch IAS officer, who became the third employee to join Maruti Udyog, now Maruti Suzuki, in the summer of 1981, and a role model for bureaucrats aspiring to change careers, he is a veteran of many battles. But ask him what a car company can do in the current scenario and his robust voice falls a few notches. "We may have to slow our investment," he says.

Maruti Suzuki, of which Bhargava is the Chairman, lords it over half the country's car market. It is about to start work on a third manufacturing plant, for which it is almost certain to go out of Haryana - where it has plants in Gurgaon and Manesar - to Gujarat. It is also slated to launch at least three new models by the end of next year, beginning with an all-new Swift in the middle of this month (August).

However, it feels hobbled. Monthly sales of cars show a trend of falling growth. In April to June this year, car sales grew a measly seven per cent, compared with 30 per cent in 2010/11. Maruti reported a decline in sales of four per cent in June, its first in a decade. The company surpassed stock market expectations by reporting an 18 per cent growth in net profit for the April to June quarter, but the growth was driven mainly by other income and analysts are reluctant to improve the stock's rating in view of the market scenario.

Labour trouble has plagued Maruti recently - including a tooldown on July 28 - and Hyundai frequently, while others like Honda and General Motors have had their share, too. The price of petrol, which drives three out of four cars sold last year, has risen from Rs 45 a litre in New Delhi to Rs 65 in less than a year. Diesel prices, too, have been on the rise. Key raw materials like steel, rubber and plastic have become costlier. To top it off, Reserve Bank of India, or RBI, Governor Duvvuri Subbarao announced the 11th rise in interest rates since March 2010, on July 26. The next day, Finance Minister Pranab Mukherjee rubbed salt into the wound by saying there was more to come. This spells terrible news for buyers, as two-thirds of all cars sold are financed by lending agencies.

Little surprise, then, that the Society of Indian Automobile Manufacturers, or SIAM, the industry lobby, has revised its growth projection for 2011/12 from 18 per cent to 10 to 12 per cent.

"Everyone will be slowing investment," says Arindam Bhattacharya Senior Partner and Managing Director at the New Delhi Office of The Boston Consulting Group, or BCG. As an estimated one-sixth of Indian manufacturing is connected with automobiles, this is a worrying sign for the economy.

The bigger question, though, is over India's aspiration, roused in part by Renault-Nissan head Carlos Ghosn, to become a hub of low-cost manufacturing, feeding the world with small and compact cars.
Manufacturing hub, Eh?
Ghosn became a legend in Japan and much of the global automotive industry a few years ago when he turned around Nissan Motor, in which Renault is the single largest shareholder. The Frenchman is also a revered figure in India, to the extent that he has been spoken of as a possible successor to Ratan Tata as the head of Tata Sons. It was not a surprise then that automobile journalists all left their desks when he came visiting four years ago. They flocked to Nashik, Maharashtra, some doing the unthinkable by asking him for his autograph. Ghosn had come for the inauguration of the Mahindra & Mahindra, or M&M, factory which was to roll out Renault's Logan, the car that redefined the low end of the sedan market in Europe.

Paying unusual obeisance to Indian manufacturing, Ghosn said: "We have come here to understand frugal product engineering and marketing. You have to learn it from someone who practises it as a way of living.... It will be difficult to develop a low-cost car of the future without involving India."

That was the time when Tata Motors was giving the finishing touches to Nano, discussed the world over with awe as the $2,000 car. At the following Auto Expo in January 2008, as Tata Motors unveiled its small wonder, Renault went on to announce a tie-up with Bajaj Auto for a car that would compete with Nano in cornering the millions of Indian buyers who were expected to switch from two-wheelers to the new entrylevel car. The market for small cars in the country was burgeoning. Suzuki's India sales, through Maruti, were overtaking its sales in Japan. There was no looking back. India was ready to cater to the rising global demand - amid increasing awareness of how precious oil and the environment were - for small and compact cars. Most of the multinational companies were already in India. Those that were not - mainly Volkswagen and Nissan - came in running.

In the euphoria, there was little heed paid to what Ghosn said when asked to predict the future of the M&M tie-up: "It is like marriage. Can you say that you will be a couple forever?" They are not anymore. Renault and Mahindra have parted ways and the Indian company is now selling Logan under the name of Verito. The two companies run by Ghosn, Nissan and Renault, started production in May last year at their joint factory near Chennai, which can roll out 150,000 cars a year in the first phase.

Arindam Bhattacharya, Senior Partner and Managing Director, The Boston Consulting Group, New Delhi
Arindam Bhattacharya, Senior Partner and Managing Director, The Boston Consulting Group, New Delhi
 'The Licence Raj is over but the inspector raj is very much there'

Given today's circumstances, is India's fledgling reputation as a low-cost manufacturing hub under threat?
First, new investments into manufacturing in the last few quarters are at their lowest in recent years. Clearly, despite the growth story continuing, businesses are voting with their money by investing more outside India. There is something, be it access to land or rigidities in labour laws, which is hurting creation of jobs. There are still too many regulations - Factories Act, Labour Act, etc. - which need to be overhauled. The Licence Raj is over but the Inspector Raj is very much there.

That is the story on the supply side. What about demand?
The demand side is more of a temporary issue. High interest rates are an issue. In auto, given the penetration levels, there is latent demand and there will always be ups and downs around the trend rate of growth. I'm less concerned about that. At the same time, it must be said that, with rising interest rates, fuel and commodity price increase, customers have become cautious. In this scenario, auto original equipment manufacturers, or OEMs, cannot pass on any price increase to customers.

How long will the demand remain depressed?
This is a difficult question. Despite all the negative sentiment, we will still have growth of 7.5 per cent or above, which is pretty good. The government has to take a call on whether it can reduce inflation only through interest rate hikes or move on the policy front constraining the supply side.

Do you see an impact on investment?

Yes, investments will be affected. I find it somewhat ironical that even though the biggest challenge we face as a nation is to create 220 million jobs in the next 15 years, we still make it so difficult for entrepreneurs and businesses to create new ones. We have to make investors feel wanted, and not as if they are on trial all the time.

How are the companies dealing with this situation?
India will continue to be a high-growth market, so multinational companies are not going to walk away but may adopt a wait-andwatch approach. But few of them are considering locating global plants in India. Indian companies are making essential investments to meet local demand, but to meet export demand, they are seeking the most cost-competitive (global) locations to serve these markets.

The first model to roll out is Nissan Micra. Renault is non-committal on Bajaj's car, which is still under development, and is talking of its own small car. Nano's monthly sales, which touched a low of around 500 last November, now average 7,000 - motorcycles sell almost 2.5 million units a month.

Michael Boneham, Managing Director, Ford India
Michael Boneham, Managing Director, Ford India
But worse tidings are that Hyundai has shifted a part of i20 production to Turkey, a move seen linked as much to the capacity constraint at its Chennai plant as to the labour trouble there. Bajaj has shifted some of its motorcycle production to China and TVS is talking about following suit. Car exports are down to a trickle, as problems in Western Europe have affected the main markets.

Nissan Micra, half of whose production was intended for export, sold 22,500 cars overseas from April to June this year, a figure that looks better against its domestic sales of 4,400. For a country that has ambitions of raising the share of manufacturing in its economic output to 25 per cent from 14 per cent in 10 years, that is bad news.

Deepikah Arora
Deepikah Arora owns Chevrolet Beat
'My car has given me independence, but parking is a major problem'

Deepikah Arora is a Delhi-based freelance designer. Until she bought her car nine months ago, she used the Metro, buses and autorickshaws. "Public transport works but waiting for buses and changing multiple trains (or metros) is not easy," she says. "Not owning a car in a city like Delhi meant that I had little or no social life. If I wanted to go out, someone needed to drop me home." Arora is glad that now she does have a car. But with no fixed job and thus, no fixed parking space in the city, she finds parking both expensive and maddening, "Parking in most parts of Delhi is getting expensive. But that is if you can find parking; some areas are a nightmare," says Arora. Being a freelance, making sure her bank account is topped up come monthly installment time is always a challenge. Nevertheless, she is glad she bought her car before the recent rate hikes. "I might not have been able to afford buying a car now," she says.

Expert voices are saying that cheap labour alone is not enough for manufacturing. Labour, depending on the capital-labour trade-off, is 10 to 20 per cent of the overall cost of manufacturing. Vikas Sehgal, Managing Director and Global Head of Automotive for Rothschild, talks about the five Ms: men (labour), money (capital), material (inputs), matter (energy, water) and mandarin (policies). "India scores well on the first but badly on the other four," he says. And global production cannot veer towards a location on the basis of one favourable factor. "If cheap labour was the all-important issue, all cars would be made in Uganda," says Sehgal.

Besides, the cheap labour in India is low on skill and has been militant in the last few years, even causing the death of the Chief Executive of an auto component maker in Greater Noida, on the outskirts of Delhi. While nearly all multinationals, except Peugeot Citron, which announced plans to come to India, are already here, they are setting up plants mainly to cater to the local demand. "Few of them are considering locating global plants in India," says BCG's Bhattacharya. According to Sehgal of Rothschild, the only reason why cars are made in India is the sixth M: market, which cannot be otherwise tapped given the high import duty.

The trouble is that the domestic market is not exactly in the pink of health right now.
Fork in the road

As soon as the RBI announced its latest 50 basis point increase in interest rates - everyone expected 25 - a collective groan rose from the marketing offices of carmakers. At the offices of Hyundai Motor India, which has the second-largest market share of 20 per cent, on Delhi's Mathura Road, Arvind Saxena, Director, Sales and Marketing, tries not to grimace. "The inquiries are there," he says, adding that sales should pick up this festive season. "The central bank is primarily concerned with inflation control, so car buyers are going to suffer a bit."

And suffering they are. Not only have interest payments for car consumers risen from under 10 per cent in late 2010 to over 15 per cent - the equated monthly installment, or EMI, on a Rs 5 lakh loan for five years has risen from Rs 10,600 to Rs 11,900 - banks are also tightening money supply. With petrol prices rising, the fuel expense for a person who drives 1,500 km a month has, assuming fuel efficiency of 14 litres to a kilometre, risen by nearly Rs 2,000. In the case of new buyers, who are paying the increased interest rate, the household budget can get precarious.

"If demand does not grow, what is the hurry to set up a new plant," asks Maruti's Bhargava. "Our sales growth forecast was 15 to 16 per cent. If the actual is only eight to nine per cent, we will have to slow down production. Who will buy?" Bajaj Auto Managing Director Rajiv Bajaj, who successfully re-engineered the company in the late 1990s by switching from scooters to motorcycles, offers solace. He believes the current gloom is little more than "the usual business cycle". His foray into China, he says, is primarily for strategic reasons, aligned with the company's international strategy.

But Bajaj deals in products which, given their low prices, may be less affected by EMI swings. And twowheelers remain untouched by the diesel dilemma, which is causing consternation among carmakers.

The price of the fuel, even after the recent increase, is Rs 20 to Rs 25 a litre lower than petrol, depending on which city you are in. Add to that the advances in diesel technology, which makes these cars travel 25 to 30 per cent farther for the same amount of fuel and has reduced the noise and vibration in the engine to take the driving experience closer to that of a petrol car. The result is that more and more buyers want to buy diesel cars even though they are priced higher - by Rs 1 lakh to Rs 1.5 lakh in some cases - than their petrol sisters. A person driving a diesel car for 1,500 km a month would make back a Rs 1 lakh price differential in three and a half years if fuel prices stayed steady.

Bhargava says that in the case of Maruti's models, which come in both the fuel variants, 90 per cent of the new buyers are queuing up for the diesel option. Hyundai's Saxena says 75 per cent of the demand for the company's newly launched Verna is for the diesel version.

This has caught the manufacturers on the wrong foot, as seven out of every 10 cars produced run on petrol. Honda, which has no diesel products in its line-up, slashed prices of its City sedan, the segment leader by far before Volkswagen's Vento diesel and Maruti's SX4 diesel stormed its fortress, by a whopping Rs 67,000, almost 7.5 per cent of the ex-showroom price. Yet, monthly sales are subdued at 6,000 units, while Vento does 7,700. A year ago, Honda sold close to 10,000 units of City every month. Volkswagen, whose Vento diesel is a runaway hit, is offering a preferential rate of interest of 6.99 per cent on loans for the petrol model. "We did not anticipate this imbalance in fuel prices so we have had to adapt," explains John Chacko, Group Chief Representative, Volkswagen.

Michael Boneham, Managing Director, Ford India , says it is not easy to balance the petrol-diesel equation. "In hindsight, we should have invested more in expanding our diesel engine manufacturing facilities."

Hyundai, which recently announced a Rs 1,500-crore investment in a new diesel plant in Chennai, believes it lost a few years due to the lack of clarity of the government on fuel price movements.

But there is not much clarity on government policy even now. Petrol prices have been deregulated, but all the oil marketing companies, except Reliance Industries and Essar, which are minuscule players in this field, are controlled by the government, which still announces major price increases. Diesel prices remain controlled.

And there has been talk about imposing extra excise, or a one-time cess, on sales of diesel cars. The Delhi government in its 2011/12 budget increased road tax on diesel cars by 25 per cent. The argument is that the subsidy on diesel should not go to wealthy car buyers.

Maruti, which made a delayed entry into the diesel segment as it waited for clarity on the government's policy on fuel prices, is still in two minds about where to put its future money. "I do not want to be in a position where I make a massive investment and am left owning a white elephant if policies change," says Bhargava.

The current problem for manufacturers is compounded by the rise in raw material costs: steel, rubber and plastic. The three together make up most of a car. The demand for more wages by employees, which is at the centre of all agitations seen in recent years, is another issue. Given the competition in the market - there are 20 cars below Rs 4.5 lakh vying for the bulk of the market - the option to increase prices is next to nothing.

Tania Sharma
Tania Sharma owns Hyundai i10
'I spend almost half my salary maintaining my car'

Tania Sharma has a daily commute of around 17 km between her house in Faridabad, Haryana, near Delhi, and her office in Delhi's Okhla area. "Every week, I spend around `2,000 on petrol," she says, adding: "Where we live, there is no public transport. Autorickshaws charge `100 for a distance of five kilometres. So I don't have much of a choice." Between her car loan and her fuel bill, half her monthly salary goes in just maintaining the car. "It might get worse. My car is quite old and servicing does not come free. I have seriously contemplated buying a new diesel car but, because it is expensive, I do not want the headache of higher monthly loan payments."

But it is not all doom and gloom out there. Carmakers have enjoyed heftier margins in India than in developed countries, which one senior executive describes as "strange". Besides, while India may not be emerging as a global hub, more and more companies are launching India-focused products, a huge change from the days when manufacturers brought old, retired models into the country. The engine of General Motors' latest launch, the diesel Beat, was developed at the company's technical research centre in Bangalore. Ford, the other American company, last year launched Figo, specifically designed for India. The trend continues with Toyota's Etios and Liva.

Volkswagen, which aims to be the world's largest carmaker by 2018, brought Vento, the sedan version of its Polo hatch, to India before other global markets.

What is more, though sales growth is down, growth continues. "For all of us to have expected sales to keep pace at 20 per cent was a bit optimistic," says Vishnu Mathur, Director General, SIAM. Like Saxena, Mathur expects things to look up this festival season. Bajaj remains optimistic, but he won't say how long the current scenario may last. "Nobody knows the future; it is futile to seek to be predictive. Instead, businesses must respond to market evolution by being adaptive," he says.

Boneham of Ford does not mind being predictive, albeit for the longer term. He expects car sales to touch nine million by 2020, compared with two million last year. The company has put its money where his mouth is; on July 28 it announced plans to build a Rs 4,000-crore factory in Sanand, not far from where Nano rolls out, in Gujarat.

As time goes by, maybe Boneham will remind us less and less of Ghosn.