No sectoral relief

Tax cuts for specific industries must be avoided

Last month, India’s automotive sector contracted by 19 per cent, the biggest fall since April 2001. Passenger vehicle sales have been dipping for some time, an indication of tepid overall consumer demand, but now commercial vehicles have also begun to suffer, indicating that economic activity is slowing. Passenger vehicle sales went down 31 per cent year-on-year in June; it was 26 per cent for commercial vehicles. Two- and three-wheelers also suffered, though less than four-wheelers. Naturally, company finances have also taken a hit, with profits falling 28 per cent in the June quarter for auto manufacturers and 21 per cent for the producers of auto ancillaries.

The problem, it is clear, is more from domestic sales, which are shrinking, than exports, which grew at a low but positive rate of 4 per cent in July 2019. The auto sector has been loudly calling for a sectoral stimulus package and, given that it accounts for a significant part of India’s manufacturing output and employs about 35 million people, the government might be willing to oblige. In particular, the sector is hopeful of a cut in the goods and services tax (GST).

The government bears some responsibility for this slowdown in the auto sector. In particular, regulatory uncertainty has taken a toll on companies. There was confusion and rollbacks galore when it came to the implementation of new fuel standards, which rendered investment difficult and also buying decision. The government’s recent stance about aggressive electrification of personal vehicles has also worried carmakers. A troubled financial sector added to the problem. Financing costs are high because the transmission of recent interest rate cuts by the central bank has been imperfect. And the crisis in non-banking financial companies (NBFCs) has played a part since those had become major sources of auto loans to consumers, funding a majority of commercial vehicles purchases, two-thirds of two-wheelers, and almost a third of passenger car purchases. Stressed NBFCs have rolled back this lending, and similarly burdened banks have cut down on exposure to companies and dealers.

Therefore, it is clear that the causes of this slowdown are not easily countered by something as simple as a tax cut. It reflects a deeper malaise: A regulatory mess, a slowdown in demand and a stressed financial sector. Thus, the government must be careful while considering the auto industry’s demand for a relief package. India’s history with sectoral packages rolled out as a consequence of lobbying has not been good. They tend to be withdrawn too late, and provide perverse incentives going forward. No sector should subsist on such policies. What is needed is something that addresses the overall situation. Here, perhaps, the government would like to consider following through on its corporate income tax cut for the largest companies. But any such overall stimulus, while tempting, should also take into account the fiscal situation. The market is already overloaded by government borrowing, which intensifies the investment crisis in the economy, thanks to crowding out. The slowdown in the economy will put further pressure on revenue and affect fiscal targets. Thus, a reform package that enables higher investment and demand without burdening the fiscal position is the only practical way out.