After two years of sluggishness, India’s automobile sector is set to post double-digit growth next fiscal, supported by improving economic growth and personal incomes.

Passenger vehicles (PVs), two-wheelers (TWs) and commercial vehicles (CVs) are expected to see 23-25%, 18-20% and 34-36% volume growth, respectively, next fiscal, compared with contractions of 3-5%, 12-14% and 19-21%, respectively, in the current fiscal.

Says Pushan Sharma, Associate Director, CRISIL Research, “Our analysis of ~800 listed companies shows salary cuts made in the first quarter of this fiscal have largely been restored by the manufacturing sector, while the IT sector is continuing to offer raises. Consequently, sentiment among urban consumers, who account for a crucial 65% of PV sales and 40% of TW sales, has improved. This, and buoyancy in rural income, augur well.”

Additionally, the increase in the cost of acquisition of PVs and TWs (including insurance, registration, down-payment, and ex-showroom price) next fiscal will be moderate at 3-4% compared with a combined ~8-11% rise in fiscals 2020 and 2021. That, along with new model launches and quest for safe personal transport options will stoke demand for PVs and TWs.

Demand for CVs is expected to be stronger next fiscal, riding on a significantly low base, improving economic activity since the third quarter of this fiscal, and government thrust on road infrastructure. Gradual reopening of schools and offices, and pick-up in the retail sector will support demand for buses and light CVs, respectively.

The CV segment, which depends heavily on financing, hard-braked as financiers lowered loan-to-value after a plunge in freight demand after the onset of the pandemic squeezed the cash flows of fleet operators. Further, only a third of the interest rate reduction has been passed on by lenders to fleet operators, leaving them chary of spending on replacements.

Since the third quarter of this fiscal, however, all three OEM segments have seen their sales volume reach and even surpass pre-Covid levels, and the recovery should be sharper next fiscal. But given the low base of the past two fiscals, volumes across segments are unlikely to reach the previous peak seen in fiscal 2019 (see chart in annexure).

CRISIL rates ten OEMs in the PV, TW and CV segments, which account for ~60-70% of the sector’s capacity. Operating margins of OEMs, which averaged between 12-14% for four years through fiscal 2019, saw a 300-400 basis points decline in fiscals 2020 and 2021 due to weak sales. The steepest fall was in the CV segment, given its relatively faster decline in volumes, followed by PVs and TWs (see chart in annexure).

Says Sameer Charania, Director, CRISIL Ratings Ltd, “Operating margins of OEMs could rebound to almost 2019 levels next fiscal despite rising commodity and freight rates because the increase in cost will be offset by higher volume and price hikes. OEMs had raised prices this January and another hike is likely in the near term.”

Strong balance sheets and liquidity helped CRISIL-rated OEMs sustain stable credit profiles despite demand volatility in the past two fiscals. These OEMs have low or nil debt, and significant surplus liquidity (over Rs 1 lakh crore as on March 31, 2020). Some also benefit from strong financial flexibility of their parent. Consequently, credit profiles have been largely stable and no CRISIL-rated OEM has been downgraded since April 2020.

Improving business prospects and limited capital expenditure requirement due to headroom in capacity utilisation will ensure that credit profiles continue to be stable. CRISIL-rated OEMs incurred a capex of ~Rs 1.0 lakh crore between fiscals 2018 and 2019 (33% higher than in two fiscals preceding), just before the slowdown hit.

Trends in consumer discretionary spending and government spending on infrastructure, especially roads, need monitoring since that would determine the extent of pick-up in demand for OEMs next fiscal. Supply constraints owing to limited availability of semiconductors would also bear watching.