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Why Auto Slowdown Need Urgent Action?


Posted on 26-Jul-2019 Comments  0

Auto Slowdown

Auto slowdown is a real problem and needs urgent action

When the chairman of the Auto Parts Association warned of nearly 1 million layoffs, it straight away triggered a panic reaction in the markets. The auto parts industry employs 5 million people and this would mean that 20% of the work force would be out of jobs. This is a pointer towards a much larger problem and that is the slowdown in the Indian auto sector. Why the auto sector is slowing and what are the options in front of the government?

Confluence of factors

In fact, there are multiple factors at play leading to this slowdown in the auto sector. Firstly, dealer inventory pile up has been a problem for quite some time. It has now reached tipping point and dealers are neither able to nor willing to carry inventory any longer. Secondly, there is a clear consumption slowdown in India. The CSFB report on consumption had clearly pointed out that weak liquidity conditions in the market had led to a sharp fall in demand for automobiles and other consumer durables. According to the report, Indian consumers were actually putting off consumption by as long as one year to tide over the liquidity crisis. The volatile prices of petrol and diesel have only added to the problems. Lastly, there is the NBFC angle to it. Tight liquidity conditions and higher cost of funds has crunched the funds available for auto lending. Even where the liquidity is available, the cost is too high! 

What can government do?

The Budget has spoken about incentives for EVs but that is still a long time away. The immediate challenge for the auto sector is to be able to survive till the demand picks up. The Budget did little to put more money in the hands of the people. It is time to think about a series of sops (both tax and otherwise) to give a boost to spending and demand for durables. Unless that demand revival happens, the auto companies are likely to be under pressure. Secondly, the government has just announced gradual phase out of 15 year old cars but that could only have a marginal impact. The big focus of the government should be to ensure that the wheels of credit for the auto industry at affordable rates start moving again. Unless that is done, any auto recovery could be elusive.

Why automobiles matter?

Autos are the best proxies for life style upgrades and consumer spending. It also creates a pool of loans for banks and NBFCs that are relatively low risk. In most countries, especially in the developed markets of the US, Japan and Europe, the auto industry is seen as a lead indicator of a turnaround in growth and consumption. If Finance Ministry is really serious about getting GDP growth back to 7.5%, then it needs to address the auto industry woes. Auto parts are just the tip of the iceberg. The sooner this is addressed, the better!

BREXIT Options

Boris Johnson needs to get done with BREXIT at the earliest

When Theresa May resigned as the prime minister of Great Britain, it was always obvious that Boris Johnson will take over. With his shock of tousled yellow hair, Johnson may have to move fast and way beyond histrionics if he has to find a solution to the intractable BREXIT problem. Broadly, Johnson has already articulated that the people of Britain have 3 options in front of them. Which option they select and how they handle the transition will determine the future of UK and its pivotal position in the global financial system.

Call fresh elections

This would be a political situation to an economic problem. Nothing much would change on the ground. David Cameron had opened the Pandora’s Box by calling for a referendum. With the referendum clearly voting in favor of BREXIT, UK really does not have too many options other than listening to the mandate of the people! Irrespective of whether the Tories return to power or Labor gets a chance, BREXIT will still have to be abided by. That is; unless of course, the people of UK themselves are willing to do a rethink. Boris Johnson has been a strong votary of BREXIT and in him UK has the best chance of finding a solution to the BREXIT issue. People may not be really keen on another election or another referendum so these options may be more about postponing the solution than attacking the problem. For now, this surely looks suspect! 

Go for no-deal BREXIT

When he laid out the options, Johnson underlined that he would not let the problem of BREXIT fester beyond the 31st of October. In fact, Johnson even affirmed that he was willing for a no-deal BREXIT. However, such a no-deal would be easier said than done. The UK still relies on the EU region for most of its trade and once the preferential system goes away, then it could be a big hit on its growth. In fact, the Bank of England has already estimated that a no-deal BREXIT could lead to a short term compression in GDP by 7-8%. As a $3 trillion economy, that could have a huge impact on the UK economy, jobs situation and the rest of the world. Notwithstanding all the bluster and high talk, UK is just not prepared for such a drastic solution.

Stitch a BREXIT deal quickly

This is the most likely and also the most sensible option for Britain. In the past, UK had been demanding too much and the EU was holding back too much. As the deadline approaches, it is time to sit across the table. EU would realize that it has a lot to gain by having access to the highly matured and globalized London markets. None of the EU markets are even close to that. UK continues to be a key interlocutor for the EU’s relationship with the US. In a volatile world, that could be the key. A smart deal with some compromises is the best bet!

Sovereign Bonds

Why the PMO is absolutely right in ordering a rethink

In the Union Budget 2019, the Finance Minister announced plans for issue of $10 billion of sovereign bonds. Amidst the fanfare, the logic was perfect. By relying on foreign currency bonds, the government will hit two birds with one stone. On the one hand, it will ensure dollar inflow and help to protect the rupee. On the other hand, it will reduce the pressure on the local bond markets and ensure that private borrowers are able to borrow at lower rates. A great idea seems to have suddenly run into rough weather. Here is why.

PMO advises caution

While it could not be confirmed, Reuters had reported that the sovereign bonds may have run into rough weather due to objections from the PMO. For a long time, the PMO has been a sounding board for all major decisions and has used its discretion to bring certain ideas into question. That is exactly what the PMO apparently did in this case. What the PMO has apparently done in this case is to ask the Finance Ministry and the key bureaucrats to rethink the idea due to its larger currency implications. Since the sovereign bonds are denominated in dollars, there is the risk that any weakening of the rupee versus the dollar could increase the burden. This will not only impact the external ratings of India but also create a vicious cycle of rupee weakening. It is precisely for this reason that the PMO has asked the finance ministry for a rethink!
Here are the risks

If the PMO has called for a rethink on the sovereign bond issue, there are several reasons for the same. Firstly, the Indian rupee has in the past shown a tendency to rapidly lose value. We saw that in 2008, again in 2013 and more recently in 2018. On each of these occasions, the rupee depreciation was in the range of 20-25% and that is hardly going to look too good when you have $10 billion of bonds payable. Secondly, these bonds are listed on international markets and that opens up the Indian government securities to listing and trading in an alien environment. The RBI and the Finance Ministry have little control over what happens to the bonds once they are traded in an international market. That surely is a big risk! 

What are the options now?

For an economy that is still not used to global bond volatility, India will have to tread a lot more carefully. We have seen the impact of risk on large economies like Spain, Italy and Greece in the past. For an economy that is already running a current account deficit of closer to 2% and a fiscal deficit that is inching towards 4%, this could be too much of a hassle. Rather, India can focus on its traditional NRI deposits and FPI flows into debt. Here there is no currency risk on the government and Indian regulator has a lot more control. The PMO may be absolutely on target in its view!

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