Auto demand indicators down

Tight liquidity and slower gross capital formation will keep growth in check

Over the last two years, the automobile sector has emerged as the flag bearer of India’s consumption story, as volumes clocked 28 per cent year-on-year. The industry touched 17 million units in CY10, having doubled over the last five years. Despite clear signs of a slowdown, optimists continue to believe strong growth in per capita incomes will result in a “consumption outburst.”

Unfortunately, the realists seem to outnumber the optimists. Most analysts are not bullish on this sector and expect the pace of slowdown to accentuate this financial year, given the macro-economic indicators that support car sales are negative.

The first indicator of healthy auto sales is the interest rate scenario. Data indicates that growth in car sales has a strong correlation with liquidity in the banking system, as 70 per cent of auto sales are financed by banks. With interest rates on a rise since last year, the cost of borrowing has risen substantially.

According to Edelweiss Capital, car sales either decline or pick up following liquidity tightening or easing, respectively, with a lag of a quarter or two. Currently, the slow offtake in deposit growth versus credit growth has induced a liquidity deficit in the system. As inflation continues to be sticky, the Reserve Bank of India’s efforts to cool it by tightening policy rates will continue.

Another economic indicator that helps gauge demand is the gross capital formation (GCF), which has been slowing this financial year. What does it indicate? Growth in GCF highlights traction in investment activity and, thus, gives a sense of how the employment market looks. Whenever the GCF growth rate drops five per cent or more, it results in sales growth decelerating to single digits. Currently, the GCF growth rate has declined by two per cent (change in actual growth rate at 26 per cent).

Moreover, given the macro headwinds, the situation is unlikely to improve in the near future. Deterioration in both these macro-indicators suggests a worse-than-expected outlook for the sector.

Those expecting auto demand to stay robust, as in the past, are in for a negative surprise. Analysts’ number crunching shows that typically, auto demand is 1.2 times the growth in GDP. With economic growth expected to hover around 8.7 per cent this financial year, the sector is likely to grow by 10 per cent. Companies having a high rural footprint could perform better.