War, oil, sanctions bring auto industry to heel

India’s automobile industry had just begun crawling out of the pandemic-inflicted slump when stiff sanctions by the West on Russia have hit the industry hard.

Both original equipment manufacturers (OEMs) and ancillaries are set for pain in the near term. With every passing day bringing news of greater devastation in Ukraine, sanctions from the West are mounting on Russia, to stifle its economy.

Both Russia and Ukraine have a significant presence in key commodities used by the auto sector. According to industry experts, the prices for commodities relevant to the auto industry have vaulted over their average levels seen in the second half of calendar year 2021. The gravity of the impact is portrayed in a report by Motilal Oswal Financial Services, that estimates the price of aluminium to be up by 48 percent, palladium (up 38 percent), rhodium (up 35 percent), platinum (up 13 percent), copper (up 15 percent) and rubber (up 28 per cent) in this period.

Commodities are up in the backdrop of rising oil and energy costs, as sanctions choke supplies in global markets. Brent crude has soared from about $60-70/bbl at the beginning of the year to almost touch a 14-year high of $140/bbl. Undoubtedly, all these cost pressures are inflationary.

Indeed, the pandemic and economic shockwaves from Russia’s war with Ukraine have brought to light the perils of global supply chains, which the world’s auto and auto component industry had mastered over decades. The smooth functioning of global logistics is likely to be affected as movement of goods into and out of these warring nations is choked. Besides, they are key suppliers of gases used to make semiconductors, which in turn could delay the normalisation of chip supplies to Indian companies making passenger vehicles, two-wheelers and commercial vehicles.

Then, there is the inevitable increase in fuel prices in India that appears to have been put on hold till the elections are behind us. Coming at a time when rural demand is yet to pick up, higher fuel prices would dampen retail auto sales in personal mobility, especially the entry-level segments. And, higher operating costs may drag down commercial vehicle sales made to fleet operators as well.

In a nutshell, a weak FY2022 and an uncertain FY2023, in terms of sales and profit margins, lie ahead for the auto sector. If the adverse situation is prolonged, then it will also squeeze auto ancillaries’ profits. The tensions in Europe and the US pose headwinds for component exports, too.

It is hard to say whether these developments would give a leg-up to electric vehicles (EV) sales in domestic markets. After all, amid talks of Aatmanirbharta and huge outlays towards the production-linked incentive scheme for auto ancillaries and battery cells, the country is still dependent on global component supplies for EVs.

Considering all these factors, investors will be wise to prepare for near-term earnings downgrades for the sector. In the medium to longer run, however, the fact that most large firms have stable financial metrics that have stood the test of time should see confidence return. But the uncertainty unleashed by the war and its unpredictable long term economic effects could weigh on sentiment.

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