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Home > Business > Budget 2006 > Special

Time's right to buy a new car

Gaurav Baser | March 06, 2006

With the Budget living up to the expectations in terms of the government's thrust on infrastructure development, the domestic automobile industry is expected to see an increase in demand, especially for small cars.

Similarly, easy lending to the rural sector by public sector banks is also likely to drive a demand-led growth for the commercial vehicle segment. Analysts say the auto industry has the potential to register steady growth in the medium term, as the government appears to be committed to infrastructure spending, more than ever before.

Going ahead, softer interest rates and government thrust on developing infrastructure and economic growth will ensure that auto is on the fast lane. Within the auto universe, cars would probably steer ahead of all other segments as the finance minister's decision to cut excise duty to half will make cars more affordable to a larger section of aspirants.

The timing of the duty cuts seems impeccable, considering that auto sales were just about showing signs of fatigue after three years of accelerated growth.

The double-digit growth seen in four-wheeler sales hit a speed-breaker in 2005, as all the segments saw growth dip to a single digit. Even the growth in passenger car sales was subdued at 5.1 per cent for the nine months ended December 2006 on account of a higher base effect.

The exponential growth, similar to the last two years, did not materialise as most of the pent-up demand (of the period FY00-FY03) was already filtered in FY04 and FY05. Further, rising fuel prices and hike in interest rates threw a spanner in the wheels.

No wonder, for the automobile industry, which recorded a relatively lower rate of growth (6 per cent) during the past 10 months compared to the blockbuster years earlier, the excise duty cut from 24 per cent to 16 per cent on small cars and clarity on small car definition were among the much-awaited announcements when the finance minister presented the Budget last week.

Surely, Maruti Udyog will be the biggest beneficiary of excise duty cut for small cars, as 90 per cent of its total car sales are made up of the 800, the Alto, the Zen and the Wagon R.

Hyundai is also expected to benefit significantly from the cut as every four out of five cars sold by the company are Santro.

Tata Motors too, is likely to be benefited as it has a monopoly in the small diesel car business, though there are concerns over its sustainability in the wake of Suzuki's upcoming diesel car later this year.

For now, however, two of every three cars sold by Tata Motors are Indica and 80 per cent of its sales are of its diesel version, which is also a beneficiary of excise cut.

According to Dipesh Sohani, analyst, Anand Rathi Securities, "Small cars already account for three-fourth of the total car sales in the country, and the reduction in excise duty will add more fuel to this trend."

The fall in prices following the duty reduction will widen the sales chasm between small cars and mid-size sedans as the price differentials between the two segments increase. Given the congested traffic conditions in big cities, as also on narrow roads, a higher proportion of small car sales will not be a bad thing after all.

Interestingly, price changes can have a dramatic impact on growth rate in case of automobiles.

For instance, according to a recent study by National Council of Applied and Economic Research, every one unit decrease in price of a car results in demand increasing by 1.8. So, assuming a manufacturing cost of Rs 200,000 and an on-road price-tag of Rs 300,000, an 8 per cent reduction in excise will result in a 5 per cent drop in the final price. This should result in the demand rising by 1.8 times or 9 per cent.

Ironically, despite very high linkages to the economy with a capital-output ratio of 2.24, India has one of the world's most highly taxed auto industries. Passenger cars in India attract excise of 24 per cent, sales tax of 12 per cent (on excise as well as freight, creating a cascading effect), road tax in the range of 4 per cent to 11 per cent and octroi.

Further, with the customs duty on components thrown in, the taxes together account for over half of what a customer pays for a car.

However, there are other factors, which are playing out in favour of the auto sector. Apart from an improvement in infrastructure in the form of better roads and higher affordability, input prices are likely to soften following the drop in import duties on steel, aluminium, copper, zinc and plastics that are used in cars.

Besides, the focus on the rural sector, farm credit and irrigation, along with that on agriculture and agri-products, will elevate the standard of living in these areas and raise demand for the commercial vehicle category, especially truck and tractors.

The largest commercial vehicle maker Tata Motors will also benefit from higher off-take of its heavy trucks, exports of CVs and cars, return of pricing power triggered by increase in freight rates and stricter overloading rules. Another positive for the company, this time, on the input side, is margin expansion from cost reduction, partly due to falling steel prices.

In an indication of what is to come, the company has garnered huge sales on the back of the impressive performance of 'Ace' in the mini truck segment. Tata Volvo continues to dominate in the road transport segment.

The Indian auto industry has also emerged as an export hub, on account of its low-cost technical manpower and increasing focus on quality. This fact is reflected in the volume exports of local automobiles, which, led by passenger cars (CAGR of 62 per cent), increased by a CAGR of 39 per cent in the last five years.

While the growing size of the market is a definite plus, there are concerns. The passenger car market has grown at 10 per cent CAGR in FY00-05. Obviously, this means more players are vying for buyers' attention.

Currently, the market is dominated by Maruti (51 per cent share), Hyundai (21 per cent) and Tata Motors (14 per cent), but analysts expect competition to intensify as players like Ford (4.5 per cent), Hond (3.5 per cent), General Motors (1.6 per cent) and Toyota (1 per cent) are expanding capacities and planning to launch new range models.

According to Ashutosh Goel, analyst at Edelweiss Capital, "Auto companies, confident of growth, are investing in capacity creation and new products. New international players are clamouring to enter the market to participate in this growth."

Another worry is oil prices, which are still boiling. "Upward pressure on oil prices and interest rates are areas of concern. Competitive pressures in the auto industry as well as certain commodity prices will also contain margins going forward," he says.

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