Scrappage Policy - Impact of Fast Pace of Auto Growth

Special Report by HDFC Securities

This is the second part of the special report brought out by HDFC Securities on Scrappage Policy. The report published in the April issue provided an insight into the growing vehicle population on Indian roads and scrappage policy. This part of the article dwells on the fast pace of auto growth, potential impact of Scrappage Policy and key challenges and concerns for auto industry.

Impact of fast pace of auto growth

Road network - leading to congestion

With increasing economic activity and growing domestic vehicle sales, the highways as well as State highways have witnessed increase in traffic. India's road network caters to 80% of country's passenger traffic and 65% of freight traffic. In spite of all Government initiatives, the transport system has proved to be deficient of handling this increasing load. A World Bank report estimated the economic losses from congestion and poor roads at 120 to 300 billion rupees a year.

As per a World Bank report, the density of India's highway network at 0.66 km of highway per square kilometer of land - is at par with that of the United States (0.65) and much greater than China's (0.16) or Brazil's (0.20). Though National Highways (NH) with aggregate length of 70,934 km represents just 2% of total road network length, they carry about 40% of total road traffic. However, most highways in India are narrow leading to congestion. Further 40 percent of India's villages do not have access to all-weather roads making transportation tougher.

India boosts of second largest road system in the world at 3.3mn km but most highways in India are narrow leading to congestion. It ranks 87th in the quality of road, way below China, Pakistan & Sri Lanka. Indian road infrastructure has seen significant improvement in last couple of years with government initiatives and investment, but growth in auto sales (ID-12%) has outpaced the growth in infrastructure (3-5%) - leading to problems of congestion and pollution.

 
 
Traffic on roads is growing at a rate of 7-10% per annum while the vehicle population growth is of the order of 12% per annum. The road development plan witnessed a significant drop in target achievement in last few years, with just 69% of target achievement for NHDP projects in last 3 years.

 
"Government Share: 74%; Private Sector Share: 26%"

Pollution levels - contribution of vehicles

With the rapid urbanization and increasing purchasing power with the middle class, India has witnessed multifold increase in the vehicle population. Last one decade has seen auto sales growing with a CAGR of over 10% making vehicles a major source of air pollution in urban India. Further, India specific issues like-types of vehicles, age of fleet, inconsistent and poor road network, and sharing of the limited space by pedestrians & non-motorized modes with modern vehicles - makes the vehicle pollution a unique challenge to handle.

With over 20% of vehicle population older than 15 years, vehicles in India are often much older and lack in the advanced technologies as compared to the developed world.

As per a study mandated by SI AM, older vehicles generate 40-60% of vehicle pollution, while constituting just 20-30% of population. The institutions and laws, responsible for managing urban air quality are also not as well developed as those in the developed countries. For instance, in Europe, all vehicle manufacturers are required to disclose the amount of carbon a model emits on per kilometer basis. No such data is available in India.

 
As per the International Organization of Motor Vehicle Manufacturers (OICA), Road transport contributes 16% of the total man made CO₂ emissions. Also, as per a EU commission communication - SEC (2006)1078 - there was a drop of 12.4% CO₂grams/km from 1995 to 2004, reflecting decreasing pollution levels with new vehicle technology & tougher emission norms.

 
Within the transport sector, road traffic is responsible for the largest share of emissions (73%).

As per CSE, emission of CO₂on India roads is expected to reach a value of 1,212 mn tons during 2035 form a value of 208 mn tons during 2005.

The country has, however, taken a number of measures for the improvement of the air quality in cities:

▪	Improvement in the quality of fuel with improved fuel quality specifications,
▪	Formulation of necessary legislation and enforcement of vehicle emission standards,
▪	Shift to BSIII and BSIV standards,
▪	Improved traffic planning and management, and
▪	Capacity building for the monitoring of vehicle emissions with institutions like CPCB and CSE.

 
 
 
Fuel consumption per capita has seen an increasing trend with rising auto sales.

 
The increase in road sector fuel consumption has been lower with more fuel efficient vehicles in last few years.

One of the key benefits arising out of scrappage policies across the world is reduction in the pollution levels with environment friendly and fuel efficient vehicles replacing older vehicle population.

US Cash for Clunkers program resulted in a 58% fuel efficiency improvement for the traded vehicles. In UK, as per government statistics, new cars in scrappage transactions are more than 25% cleaner in terms of carbon emissions than the older vehicles they replaced.

Considering rise in the pollution levels, especially in metro cities, owing to higher vehicle population, we consider introducing scrappage policy will be instrumental in making environment a lot cleaner.

Potential impact of scrappage policy

Since economic liberalization and de-licensing in July 1991, the vehicle population on Indian roads has grown at a spectacular rate of 9% leading to over 102 mn registered vehicles on road in 2010. Out of these, close to 20 mn vehicles are older than 15 years on road.

As pera study mandated by SIAM, older vehicles generate 40 - 60% of vehicle pollution, while constituting just 20-30% of population. About 1.6 - 2% of vehicles get scrapped every year in India, and absence of formal scrappage policy makes the control of waste disposal more difficult. As the vehicle dismantling and scrappage industry is completely unorganised in India, most of the leftover materials, including lead and asbestos based components, are dumped along with other municipal waste, posing a serious threat to environment.

Rapid growth of vehicle population coupled with lack of infrastructure makes it imperative to have a formal fleet management and scrappage policy for India. Lack of the same might lead to environmental and safety concerns on road.

SIAM has recommended a cut-off age of 10 years for commercial vehicles and 15 years for passenger vehicles in India. As India is moving to new and stricter emission norms currently, we believe, it is an appropriate time for incentivising scrappage of older vehicles. Further, the incentives can be offered in the form of excise duty and VAT benefits to avoid any burden on government while generating additional income.

Boost the entire economy through various linkages

Introducing scrappage policy will not only improve the quality of vehicles on road but also holds the promise of performing a remarkable public policy turnaround - stimulating the economy, improving the environment and better employment considering robust industry growth.

Boost to the auto industry

Scrappage scheme worldwide has lead to an increase in the sales of vehicles boosting the complete economy with higher production and increased employment opportunity. In US the program resulted in close to 0.7 mn dealer transactions in a span of a month. In UK the scheme accounted for 20% of new vehicle registrations during that period resulting in a total of 392,500 new cars and 7,300 vans registrations in 11 months. China witnessed a 50% jump in sales in 2009 and over 30% jump in 2010.

 
Such a success of the scheme not only resulted in a boost to the vehicle demand but also encouraged more consumers to use new, safer and environmentally friendlier models, while simultaneously getting the older ones off the road. In India, we expect scrappage policy to create a replacement demand for over 20% of current vehicle population - close to 20 mn registered vehicles as of 1996.

 
Higher sales of smaller and more fuel-efficient cars

Analyzing Trade-in and new vehicle purchased trend of US cash for clunkers program; we can expect the sales of smaller and fuel-efficient cars to get a boost in the scrappage policy in India.

US government launched "Car Allowance Rebate System (CARS)", popularly known as "Cash for Clunkers", on July 1, 2009 in order to provide stimulus to the economy by boosting auto sales while putting safer and fuel-efficient vehicles on the road.

The initial $1 billion, as appropriated for the program, got exhausted within couple of weeks and the government had to approve an additional $2 billion for the same. The program resulted in 690,114 dealer transactions, amounting to a total of $2.877 billion in rebates.

The program witnessed a trend shift towards more fuel-efficient Japanese & Korean vehicles. At the end of the program, Toyota accounted for 19.4% of sales, followed by GM with 17.6%, Ford with 14.4%, Honda with 13.0%, and Nissan with 8.7%.



 
In addition, the program provided good news for the environment with shift from inefficient trucks and SUVs into new more fuel-efficient cars. As part of the scheme, 84 per cent of consumers traded in trucks, while 59 per cent purchased passenger cars resulting in a 58% fuel efficiency improvement.

The US Department of Transportation reported that the average fuel efficiency of traded in was 15.8 mpg (miles per gallon), compared to 24.9 mpg for the new cars purchased to replace them.

 
Analyzing the fuel efficiency of the various car models in India and the past sales trend, we expect Tata Motors, Hyundai and Maruti to gain the most from the scrappage scheme in India. Though with limited product range and network, companies like GM and Ford are also present in the segment and should benefit from the replacement demand.

Reduction in the carbon emission

In the UK, the new cars purchased under the scrappage scheme, are recorded close to 25 per cent cleaner in terms of carbon emissions than the older vehicles they replaced. According to a report from the Society of Motor Manufacturers and Traders (SMMT), on average, new cars emitted 149.5g of CO₂ per km in 2009 - a 5.4% reduction on the average 2008 figure.

This was the best year-on-year improvement since the SMMT began to keep records of this kind from year 1997. The average emission of cars bought through the scheme was 133.3g/km, which was 26.8% below the average of the vehicle being scrapped (182.3g/km).

Spillover effect: Manufacturers with additional capacity to gain

Scrappage policy will make close to 20 mn registered vehicles eligible for replacement benefits. As this will induce many customers to prepone their purchases to avail the benefits, the sales cycle might shift and consolidate into a short time frame. This sudden increase in sales will put further pressure on the already constrained manufacturer's capacity.

With dominant players in small car segment like Maruti and Hyundai, already running packed capacity, we expect manufacturers like Honda, Nissan and Ford to gain with the spillover demand.

 
Most of the manufacturers have announced investments to enhance their production capacity.

 
 
Key challenges and concerns

Strong industry growth discrediting any need for incentives

One key argument against the scrappage scheme could be strong industry growth at present discrediting any need for incentives to enhance sales. We refute this argument considering high population of older vehicle still operational on road effecting the air quality and safety of passengers. The biggest gain through this scheme will be better vehicle quality on road leading to cleaner and safer road transport.

We expect the scheme to be revenue positive for Indian government. Unlike the schemes in developed nations, we expect the scheme in India to be more on duty & tax rebates rather than cash incentives, generating additional revenue for the government.

Sudden pressure on the manufacturers' capacity

We believe that if not implemented in a planned manner, scrappage runs the risk of creating surplus capacity driven by sudden surge in demand. Manufacturers, who are already facing capacity constraints, will have to cater to the enhanced demand by investing in capacity expansion. Considering the jump in the demand would be one time during the scheme, the manufacturers might end up with additional capacity. Scrappage scheme has the potential to entice consumers to pre-pone the purchase decision and hence skew the demand pattern.

Effect secondhand auto market

Scrappage scheme runs with the concern of removing many usable old vehicles from the road, affecting potential sales in the second hand auto market. This will be more prominent in the rural areas where lots of older cars are transferred from cities.

But considering that the prime agenda of the program would be to remove the inefficient and polluting vehicles off the roads, including from the secondhand car market, this stands justified. Further, with suggested age for scrappage being 15 years for passenger vehicles and 10 years for commercial vehicles, even safety and usability of these vehicles in secondhand market is questionable.

Updated vehicle registration system crucial for success

In order for the scheme to be effective, it requires an up to date vehicle registration system and good inspection system. There is no such integrated database for registered vehicles available in India. Building the same will require time as well as result in expenditure of resources. But in the long term, this investment looks inevitable and will lead to multiple benefits in managing transportation effectively.