What the auto slump reveals
The recession signals a larger malaise because the automobile industry was one among the few industries that had successfully restructured and registered rapid growth in the post-liberalisation era.
A government grappling with the problem of slowing growth, reflected even in its allegedly inflated GDP numbers, is now confronted with a crisis in the automobile industry. The panic visible in statements by industry spokespersons can be traced to two trends. First, sales of automobiles and two-wheelers that were slowing earlier, have been contracting for some time now. Second, recent evidence that the demand contraction is only intensifying with sales in July relative to the corresponding month of the previous year falling by 18.7 per cent in the case of all categories of vehicles and by 31 per cent in the keenly watched passenger vehicle segment. That marked the worst monthly sales performance in almost two decades.
The recession signals a larger malaise because the automobile industry was one among the few industries that had successfully restructured and registered rapid growth in the post-liberalisation era. India’s industrial sector as a whole continued to languish after liberalisation in 1991, with the share of manufacturing in GDP at a low 17 per cent today, having peaked at just 18 per cent compared with 30-40 per cent in other Asian emerging market countries such as China, Korea, Malaysia and Thailand. In that small manufacturing sector, the automobile industry is a major presence. So, a leading driver of even limited manufacturing growth under neoliberalism is losing momentum.
Explanations for this recession in the industry have referred to the effects of the overall economic slowdown, the liquidity crunch resulting from the IL&FS crisis that has adversely hit the volume and increased the cost of credit for automobile purchases, and the uncertainties created by the government’s new deadlines for enhancing environmental standards and making the transition to electric vehicles, which have encouraged consumers to postpone purchases. This narrative does not, however, capture the full picture.
To capture that we must turn to an understanding of the factors that stimulated the demand that underlay the rapid growth of the automobile sector. Unlike in the 1980s and, to an extent, the 1990s, public expenditure was not the principal stimulus to growth of employment and income over the last two decades. Rather, starting from the early 2000s, credit-financed private consumption and investment provided the stimulus for growth, especially in manufacturing. The huge increase in liquidity in the economy, facilitated by the surge in foreign capital flows, especially flows of financial capital, and the accommodative stance of the Reserve Bank of India, facilitated a credit boom that led to rapid growth. But for that boom to materialise, this supply side push had to be accompanied by increased credit offtake, which required lending to new areas and hitherto untouched borrowers.
One area to which lending increased sharply was the retail (or personal credit) sector, with substantially increased lending for housing investments, followed by purchases of automobiles. If the share of the retail sector in a rising volume of lending was to be enhanced, it was necessary to widen the universe of borrowers, and bring in those who were outside the credit net earlier. Besides attractive interest rates and lowered norms for contributions by the borrowers themselves (or high ratios of loan amounts relative to the value of the asset whose purchase was being financed), this was done by diluting requirements such as collateral or certainty about the future income stream of the borrower.
An important shift here was the increased acceptance of the assets whose purchase was being financed as collateral. If the asset concerned was perceived as having a high resale value and a ready market, it could in the event of default be attached and sold to recover some or all of the value of the loan. The process can turn difficult only if the proportion of defaults crosses a threshold where the market for the asset concerned is more than saturated.
As noted, this shift in the credit environment facilitated the automobile boom, with manufacturers or retailers entering into tie-ups with banks and financing firms or establishing financing arms of their own. But as exposure to individual segments of the retail loan market increased, with increased exposure to borrowers earlier not considered creditworthy, the potential for default increased. A late-2018 study by credit bureau Transunion Cibil found that, among unsecured personal loans, the highest delinquency rate was for housing or property loans, at 3 per cent. But, automobile loans that are on average much smaller were a close second with a 2.75 per cent delinquency rate.
These defaults were occurring when evidence was accumulating that the credit boom had proceeded to an extent where aggregate non-performing assets (NPAs), especially on loans to corporates, had increased hugely. While initially this was seen as a problem affecting the banking sector, the IL&FS crisis made it clear that a major non-bank financial institution was also over-burdened with bad debts resulting from unbridled lending without due diligence. This had its reverberations. Banks and other financial players turned cautious and held back on new lending to NBFCs, having burnt their fingers in the IL&FS episode and given their own large NPA stocks. Since these NBFCs borrowed short term and lent out long term, returns on their lending do not help clear all of their short term loans when they fall due. They need to keep renewing those loans and obtain new loans, to sustain and expand business. However, because of the “liquidity problem” resulting from banks turning tight-fisted, they were being squeezed out of the market for credit, making it difficult for them to secure funds to meet their payments commitments and keep business going.
Needless to say, both banks and NBFCs were major sources of credit for buyers of automobiles. As banks got wary of increasing their relative exposure to the automobile sector and NBFCs could not secure funds at reasonable rates, lending for automobile purchases was adversely hit, triggering the slowdown. Other factors like high prices because of the 28 per cent GST rate and the cost implications of and uncertainty stemming from new environmental norms only aggravated this basic tendency. The crisis is now visible on many fronts: production cutbacks by vehicle manufacturers, increased unutilised capacities in ancillary original equipment manufacturing units, and losses suffered by and closures of retail dealers.
In sum, the crisis in India’s auto sector is suggestive of a crisis of the regime of growth in which debt-financed private spending was the bubble on which the economy rode. It is in this light that the demands of automobile manufacturers that the government must address the crisis by significantly reducing the GST rate and by forcing banks to help ease conditions in the market for automobile credit has to be assessed. The automobile sector is an important contributor to aggregate GST revenues, so reducing the GST rate on automobiles would significantly reduce resource mobilisation by and the spending capacity of the government. Moreover, the factors slowing growth in the automobile industry are operative in other areas such as the housing sector and consumer durables as well. Supporting one sector (automobiles) with tax cuts, would lead to similar demands from elsewhere aggravating the already poor collection of GST revenues. Government spending would be hit and, therefore, so would growth.
Further, getting banks burdened with bad debt and losses to increase exposure to areas where defaults are likely to rise would be difficult. If that does happen under government pressure and NPAs increase, the banks would have to be recapitalised to keep them solvent. A government that claims to be cash-strapped would be hard-pressed to do that, forcing the banks to retreat once again.
Meanwhile, large losses of employment in the recession affected sectors would also dampen demand. In sum, the auto industry crisis does not stem from ephemeral factors that are easily fixed by government. It reflects a crisis of the neoliberal regime of accumulation and needs more fundamental restructuring of policy. This business-friendly government is unlikely to recognise that, so the crisis is likely to be prolonged.