Why this credit rating firm has downgraded outlook for auto sector for next fiscal year

The Indian automobile sector has been suffering over the past couple of years due to low demand, especially in rural areas, and the impact of the Covid-19 pandemic as well as supply-side problems related to semiconductor chips. And the coming fiscal year is unlikely to result in a major bump in sales for the sector.

India Ratings and Research (Ind-Ra), an affiliate of global ratings firm Fitch, has revised downwards its outlook for the auto sector for FY23 to ‘neutral’ from ‘improving’, primarily on account of supply-side constraints and muted rural demand. Ind-Ra expects domestic auto sales volume to grow 5-9% year on year in the year ending March 31, 2023, after three consecutive years of decline.

While Ind-Ra had previously expected the sector to grow 12-15% this year, it had later revised the estimates and in a report two months back said it expected domestic sales volume to either be flat or decline to the extent of 4%.

This was largely due to tepid demand for two-wheelers, which account for over 80% of the total industry volumes, reduced disposable income of buyers of entry-level vehicles, weak demand from rural areas, as well as deferral of re-opening of colleges and offices amid the third wave of the pandemic. This would be exacerbated by lost production amid semiconductor shortages, particularly in passenger vehicles (PVs).

However, now the rating agency feels the sector would decline 5-8% in the year ending March 31, 2022.

It projects PV volume could grow 5-9% in FY23, compared with estimated FY22 growth of 8-12%. Growth next fiscal year will be driven by intermittent improvement in consumer sentiment and continued preference for personal mobility although supply chain issues could weigh on sales, the ratings firm said.

“Semiconductor chip shortages could persist for the next few quarters while improving gradually. Increased cost of ownership, a slower revival in the purchasing power of lower-end consumers and a muted rural demand could limit two-wheelers growth at 5-8% for FY23 (FY22: likely down 10-13%),” according to Ind-Ra.

Bright spot and possible headwinds

The only clear bright spot is commercial vehicles (CVs), whose volumes are likely to grow in high double digits of 16-22% in FY23, compared with FY22 estimate of 20-24%. This is mainly supported by medium and heavy CVs, aided by an uptick in economic activities and increased infrastructure spending.

Meanwhile, Ind-Ra expects limited rating movements in the sector in FY23 and has maintained a ‘stable’ outlook.

It feels that the industry revenue growth will also temper down to 13-15% during FY23, after likely growth of 14-17% in FY22. Revenue growth will be largely driven by price increases undertaken by original equipment manufacturers and increased mix of CVs, which have higher realisation.

EBITDA margins are likely to remain flat over FY22-FY23 as better operating leverage and an improving product mix could be offset by firm commodity prices.

The ongoing Russia-Ukraine war could increase commodity prices, crude oil prices, and exacerbate supply chain issues. In addition, a slower recovery in rural sales and further price hikes by original equipment manufacturers could act as possible headwinds for the sector, Ind-Ra said.