The Indian economy has faced a few tough years recently. This article looks at the current economic environment, actions taken by the government and their impact, in particular on the commercial vehicle industry as a key economic indicator, and will provide an outlook towards FY16.
The current economic environment
As Fig. 1 shows, the last 2-3 years have been challenging for the Indian economy. However, the last 2 quarters have provided us with the first rays of hope after a long time. Quarterly GDP figures lead to an average growth of 5.5%, clearly higher than growth in FY14. Inflation has come down dramatically. In November 2014, Wholesale Price Inflation was 0%, Consumer Price Inflation as low as 4.4%. The main drivers were food inflation (reduced from 9.6% in May 2014 to 4.9% in December 2014) and fuel inflation (10.5% in May 2014, -8.5% in December 2014). As a consequence, RBI was able to reverse monetary policy and to reduce interest rates by 25 bps. Capital inflows into the economy have been strong and quarterly FDI has been consistently above USD 7 bn over the last 3 quarters. Business confidence indices such as IMA's BCPI and HSBC's Purchasing Manager Index point solidly towards expansion.
Some areas of concern remain and indicate that a full recovery is yet about to happen. IIP numbers still fluctuate around zero and passenger car sales have been a somewhat erratic surging strongly after the election of the new government and falling into negative territory in September and October. Non-food credit growth remains in the low double digits indicating that full confidence into the turnaround of the economy is yet to emerge.
For OEMs, dealers and fleet operators, the overall environment has improved markedly. Falling diesel prices and reduced interest rates had a positive impact on the profitability of transporters. At the same time, truck capacity utilization has improved and drives transporters to look seriously at both new purchases and replacements. Hikes of 25-40% in rail haulage charges lead to a 15-20% cost advantage of road transport vs rail and drive additional traffic from railways to the trucking industry. Strict overloading bans and their enforcement lead to additional capacity addition, the phasing out of the excise duty led to a significant pre-buying effect. Auctioning of coal, iron ore, copper, zinc, bauxite and other mines bodes well for tippers.
As a consequence, the MHCV cargo segment is likely to see an overall growth of 12% and end up at about 2/3 of FY11 volumes. While ICV and MCV Cargo will contract by 13.2% and 5.3%, respectively, Rigids (> 16t, including tippers) will grow at a respectable 20.6% and Haulage Tractor-Trailers (> 26.4t) show a very strong performance with growth of about 82.7%. With this growth, Rigids will be at close to 70% of FY11 volumes while Haulage Tractor-Trailers will be at 83%, respectively. Overall, a clear shift to higher tonnage vehicles is visible across the segments.
For OEMs, this is good news. Margins in the MHCV segment are typically good and OEMs have worked hard to increase efficiencies during the last 2-3 years. Many monetized non-core assets, reduced working capital, reinforced product line ups, increased their focus on alternative business areas such as exports and defense business, etc. Tata Motors reports a reduction of breakeven points in the CV business to 35-40% from an earlier 50%, a number that is far better than that of most Triad competitors. With higher capacity utilization in key factories due to stronger sales, we are likely to see stronger results coming out of these OEMs going forward.
The improved business environment will also lead to a gradual reduction in discounts. Current discounts are still around 10% but have come down from 15+% during the height of the crisis. This will lead to better financial health of OEMs and dealers alike.
Unfortunately, the picture is not uniform across all segments at the moment. Due to severe difficulties in financing, the SCV segment continues to contract in FY15. Extrapolation of sales figures for FY15 indicate a 53% drop vs FY14 in the SCV passenger segment and a 14% drop in the SCV cargo segment. With official NPAs at 4-6% (and off-line discussions that indicate 3-5 times higher dud loans), banks will shy away from financing assets that are perceived as risky for some time to come. For LCVs, the scenario is slightly more positive. Volumes in FY15 for both, the Passenger and Cargo segment, are likely to stagnate at FY14 levels.
Impact of the new government
The positive momentum and desire for development, growth and transparency that brought the BJP to power about 8 months ago, led to BJP victories in Haryana, Maharashtra and Jharkand as well as a strong showing in Jammu and Kashmir. Since then, the government has amended the companies act, repealed about 90 obsolete laws, introduced the GST bill and issued ordinances regarding the new coal and insurance bill, the amended land acquisition act, the allowance for spectrum auctions and the regularization of Delhi's unauthorized colonies, among others. Steps taken to remove discretion and simplify procedures, e.g., related to factory inspection and forest and environmental clearances are also noteworthy as are the clearance of 186 of 557 pending projects to the tune of INR 6.9 trn and the increase in FDI limits through the automatic route to 49% in Defense. Banking reforms and a protection of bank PSUs from political influence are being talked about and would go a long way in safeguarding the banks from getting into the kind of trouble that they are currently in.
On the foreign policy front, the government has struck a vital and remarkable alliance with the US and Japan and continues its friendship with its largest trading partner, the EU. These alliances will drive benefit for India in terms of increased investments and better market access.
All these steps are positive stimuli for FY16 and beyond and a GDP growth of 6.5% for FY16appears realistic. With this kind of growth, India may be poised to grow faster than China. To keep the momentum and increase the impact of these measures, a strong, pro-growth budget is necessary. Key steps are increased investments and ensuring that investments that are cleared are spent during the fiscal year, an introduction of GST, labor reforms, tax reforms to simplify taxes for companies and individuals, and a stringent drive to cut red tape as well as a recapitalization of key banks.
These reforms and their implementation are crucial. Take GST as an example. Lack of adequate infrastructure and an integrated tax structure continues to lead to severe inefficiencies of truck operators. On average, a truck covers 280 km/day vs a global average of 400 km/day and 700 km/day in the US. Logistic inefficiencies in India lead to an escalated logistics cost that is 200 bps higher than that of best-in-class countries with significant negative impact on the Indian economy.
Recapitalization of banks is another example. With potential dud loans of banks being 3 to 5 times higher than the 4-6% NPA that are published, we may face a situation where dud loans are large enough to wipe out bank equity capital. Together with more stringent guidelines such as Basel III, banks will stay away from financing risky assets such as steel and mining projects that typically require spreads that are 4-5% higher than the base rate. A recapitalization, some estimates put the amount at approximately USD 85 bn, is potentially necessary to correct this situation.
The sudden drop in oil prices is a windfall profit for the government in some sense. It has driven inflation down and allowed the government to increase its war chest of forex reserves to record highs. Low inflation does give RBI an opportunity to lower interest rates. If inflation remains subdued in FY16, a further rate cut of 50 to 75 bps should be possible with corresponding benefits for private consumption.
Low oil prices are also a reflection of global political instability and economic weakness. Contrary to the initial years of the UPA government, the current government will not be able to sail a wave of global economic expansion. It is likely to have more head- rather than tailwinds from the global economic environment increasing the need to drive reforms and get the job done within India. If the government tackles this challenge successfully, however, it does have the opportunity to position India as the next growth superpower surpassing traditional rivals such as China.
Outlook on FY16 - the good days should soon be here
As discussed in the previous two sections, the overall environment is positive for India as an economy and as a consequence for the Commercial Vehicles sector. Based on solid GDP growth of 6.5% in FY16, we should see strong double digit growth in MHCVs. MHCVs reflect the overall strength of the economy and are normally the first facing decline when the economy is in a recession. They also serve as an lead indicator of better times when the economy turns around.
Based on this rule-of-thumb, we should see a turnaround in the SCV and LCV segments latest in the second half of FY16 with overall growth rates in the upper single digits. Interest rate reductions and their impact on increased consumption will have a major impact on these segments since they are focussed on last mile distribution.
The financial situation of OEMs, operators and dealers should gradually improve during FY16, however, new capacity additions are unlikely to happen before FY17 since capacity utilization rates still have some way to recover to reach 80+%.
In short, with a focus on implementation of reform and a strong, pro-growth budget, we are certain to finally reach the light at the end of the tunnel.