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Passenger cars: Lets talk fundamentals! - Views on News from Equitymaster
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Passenger cars: Lets talk fundamentals!
Jan 2, 2006

Segment Price range % market share
A upto Rs 300,000 14.2%
B 300,000 to 500,000 60.5%
C 500,000 to 1,000,000 22.2%
D&E above 1,000,000 4.1%
The passenger car industry is said to be a reflection of the economy. Since disposable income growth is broadly linked to economic growth, demand for passenger cars is a function of these two macro-variables. Unlike the developed and some of the developing economies (where owning a passenger car is a necessity), in India, it is still an aspiration-based product (Source: Our interaction with Peugeot and Maruti).

Generally, it is said that per capita income of US$ 1,200 to US$ 1,300 is the threshold, beyond which demand for passenger cars grows at a faster pace. India’s per capita is estimated at around US$ 600.

In this article, we analyse in detail the key variables that play a role in influencing demand for cars, based on our understanding during our conference call with Maruti.

Class %
GDP share
PCI Max buying
Rich 20% 41% 55,350 968,625
Middle 60% 51% 22,950 401,625
* classification based on UNDP human report 2004
Cost to income ratio: The cost of buying the car represents just 1/3rd of the total cost of owning a car during the life cycle. The rest of the costs are accounted by maintenance and running costs (read fuel). Based on our interaction with Maruti and our own calculations, we understand that the ratio of price to income ratio ranges between 2.5 times to 3.5 times. If one considers this factor, it is not surprising that almost 95% of passenger car sales is contributed by A, B & C segment cars.

Year 2003 2005
Loan amount 300,000 300,000
Max. tenure 3 years 5 years
Rate of Interest 10.5% 9.0%
EMI 9,751 6,228
% reduction   56.6%
Loan affordability: This is a function of the tenure of the loan and interest rates. Apart from income levels, affordability of loan has an important bearing on the demand for passenger cars. To give a perspective, with interest rates softening over the last five years and better repayment options, there is a significant reduction in the EMI, from a customer perspective. To put things in perspective, today, car loans are available for 5 years (around 3 years till 2003). Taking the current interest rates and elongated repayment option, there is a 57% reduction in the EMI (as can be seen from the adjacent table).

Replacement age: Another important factor that affects the overall demand, especially when the economy is performing well is the replacement age. Based on our interaction with the industry people, we understand that the replacement age of a car has reduced from around 7 years two years back to around 5 years currently.

Duties and taxes: The Indian automobile industry is amongst the highly taxed ones. To put this in perspective, passenger cars currently attract excise duty of 24%, sales tax of 12% (on excise as well as freight, thus creating a cascading effect), road tax in the range of 4% to 11% and octroi. Further, with the customs duty on components thrown in, almost 50% of the retail price is accounted by taxes. Another interesting fact to note is the correlation of a reduction in excise duty and volume growth. As per National Council of Applied and Economic Research (NCAER), the price elasticity is 1.8 times, indicating a change in demand by 1.8 units for a change in price by 1 unit. Historically, reduction in taxes and duties has played a catalyst role in sprucing demand. Apart from this, there are other factors like fuel prices and road infrastructure, which are relatively less significant.

To conclude…
The exponential growth in car demand, over the last two years, was largely a factor of pent-up demand, strong GDP growth, new model launches, benign interest rate environment, shortening of replacement cycle and reduction in excise duty. Having said that, with plethora of launches expected in the next two to three years, we expect the replacement cycle to shrink further. We also expect interest rates to harden, albeit marginally. This could marginally affect car demand, as more than 75% of the new purchases are on credit. Similarly, the scenario on the fuel price is not positive, unless the government reduces the taxes on the petroleum products. Going forward, we expect demand for cars to stabilise in the range of 8% to 9% CAGR in next three years, as against 15% CAGR growth witnessed in last three years.

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