Stuck in reverse
How a shadow banking crisis sent India’s auto sector into a tailspin.
● Sudhir Gharpure and his sales team sat chatting at a big Maruti Suzuki dealership on the outskirts of Mumbai two hours after its doors were opened on a recent Saturday morning. Not a single customer was in sight.
“There used to be close to 15 or 20 bookings each day, but now we’re down to 3-5 on good days,” said Gharpure, the general manager at the dealership.
His experience is not an isolated one. Across India, dealerships are being pushed out of business and the automobile sector is going through its biggest slump in nearly two decades. Passenger vehicle sales have fallen for nine straight months through July. The year-on-year decline of 20.5% in May was the worst in 18 years, but preliminary figures for July show a drop of 30%.
The slump in India, along with a simultaneous slide in Chinese auto sales, is a blow for manufacturers wrestling with higher costs driven by more stringent emission norms and a push to develop electric cars.
Unlike in China, where the drop in car sales has been caused largely by new emissions rules, India has seen a mix of factors that have combined to erode demand.
They include the abrupt removal from circulation of high-value banknotes in late 2016, higher tax rates under the new Goods and Services Tax, a ride-sharing boom led by the likes of Uber and Ola, and a weak rural economy.
But many dealers and automakers agree it is a deepening liquidity squeeze among India’s shadow banks that has been the biggest single factor in the sales collapse, which some fear may lead to more than a million job losses.
Non-bank finance companies (NBFCs), or shadow banks, have dramatically slashed lending since the collapse of one of the sector’s biggest players in late 2018.
Infrastructure Leasing & Financial Services Ltd (IL&FS), was a behemoth in shadow banking and its defaults and unravelling, amid fraud allegations, have dried up funding for rivals and led to a surge in their borrowing costs.
Non-bank or shadow banking firms generate credit outside traditional lenders, by means such as collective investment vehicles, broker-dealers or funds that invest in bonds and money markets.
In India, NBFCs in recent years helped fund nearly 55-60% of commercial vehicles, both new and used, 30% of passenger cars and nearly 65% of the two-wheelers in the country, according to the ratings agency ICRA.
To make matters worse, the stress in the auto market has also prompted banks to begin trimming their exposure to the sector.
“The car doesn’t sell, it’s the finance that sells,” said R Vijayaraghavan, a senior marketing consultant at the same Mumbai dealership. “Today the finance is not selling, so the cars are not selling.”
A total of 286 dealerships have shut down in the last 18 months across India as rising costs for inventory management have made businesses unviable, according to the Federation of Automobile Dealers Association (Fada).
“The slowdown in the (NBFC) sector has dragged down vehicle sales growth,” said AM Karthik, financial sector head at ICRA. “Now the auto slowdown is becoming more visible as the liquidity squeeze continues.”
Automakers including Maruti Suzuki, Tata Motors and Mahindra & Mahindra are feeling the heat and have either cut production or temporarily closed plants to rebalance inventories.
According to Fada data, passenger vehicle inventories now stand at 50-60 days, up from around 45 days earlier, while those of two-wheelers are even higher at 80-90 days.
“We are asking dealers to maintain an inventory of 21 days, which is almost half of the current levels,” said Fada president Ashish Kale.
At least four dealers from different brands said, however, there was little scope to reduce inventories as automakers were pushing them to buy stock, despite minimal demand even after they offered heavy discounts and other incentives.
While 70-75% of car sales were previously financed in-house by NBFCs or bank agents sitting at a dealership, that has fallen to about 50%, say dealers. Buyers are struggling as lenders seeking to shore up their books tighten their rules.
Moreover, as many NBFCs typically lent to less creditworthy clients, banks are reluctant to rush in to fill the void, as they themselves are struggling to cope with about US$150 billion in bad loans.
“The banking sector is certainly one of the factors that has affected the growth of the industry,” said RC Bhargava, chair of Maruti Suzuki, noting interest rates for car buyers have gone up in the last 12 months despite the central bank cutting rates.
With the auto sector employing 35 million people directly and indirectly, accounting for 49% of manufacturing GDP and 7% of GDP overall, the fallout from the slump is huge and presents a big challenge to the Modi government as it begins its second term.
The entire supply chain, from vehicle manufacturers to component makers, is bleeding.
“I’ve been making my payments for the last 30 years and the lenders know me,” said Adarsh Gupta, the director of finance at Autolite (India), a component manufacturing firm. “But even a two-day delay has people crying that I will default.
“I too want to pay, but because of the fall in cashflows I’m facing short-term issues and because of that it’s difficult to get more financing. This is the vicious cycle we are in.”
Still, automakers are hopeful of a recovery in the months ahead, helped by the September-December festive season that traditionally brings a surge in consumer spending.
“One can only wish that things improve sooner rather than later. With festive demand starting to seep through, we should start seeing a gradual improvement in sales,” said PB Balaji, group chief financial officer at Tata Motors.
Analysts are more sceptical, though, and say that without cheaper and easier vehicle financing, the chances for that are low. With no silver lining in sight, analysts fear bad debts could mount in the auto sector, forcing banks to further reduce their exposure.
“We see market prices and sales coming down, so there may be issues,” said a top official at the Indian Banks’ Association. “We could see a spillover in terms of bad loans for the overall sector, but we are going to wait and watch.”
Dealers are hopeful of riding out the current downturn as the broader growth outlook for India remains good, but there could be a lot more pain before a recovery kicks in.
“The future is going to be multi-brand car showrooms,” said Vijayaraghavan as the Mumbai dealership. “That is the only way for dealerships to survive going forward, as overhead costs need to be shared.”
“The car doesn’t sell, it’s the finance that sells. Today the finance is not selling, so the cars are not selling” R VIJAYARAGHAVAN
Mumbai dealership marketing consultant