India Ratings and Research (Ind-Ra) believes that the domestic auto sector could continue to face supply chain headwinds, especially due to semiconductor chips shortages, over the remainder of FY22. This is likely to curtail the sales growth expected for the auto industry in FY22, particularly in the passenger vehicles (PV) segment, and also adversely impact profitability. Ind-Ra expects the semiconductor chips shortage to continue until end-1H22, although the availability could gradually improve over this period. Ind-Ra further expects original equipment manufacturers (OEMs) to reassess their supply chains to diversify and/or partially localise their raw material requirements over the near to medium term.
The government through the launch of investment schemes has showcased heightened focus on electronics manufacturing, including semiconductors. However, as the build-up and ramp-up of semiconductor capacity is a lengthy process, any investments are likely to aid local supply chains only over the medium to long term.
Impact on Domestic Auto Production: With the progressive increase in electronic content in vehicles, semiconductors are used in various parts such as automatic headlamps, instrument gauges, parking sensors, anti-lock braking system, and infotainment system. Typically, these find larger application in PVs than in two-wheelers or commercial vehicles. To mitigate lower availability of semiconductors, OEMs have been prioritising the use of chips in their more-profitable models, while also developing model variants with fewer accessories that require chips. PV OEMs such as Maruti Suzuki India Limited, MG Motor India Private Limited and the Renault Nissan Alliance, among others, have also reduced production and/or taken selective plant shutdowns, due to the shortages.
Ind-Ra believes that the demand tailwinds for the PV segment remain intact. However, the semiconductor supply scenario is evolving, and hence, the supply-side shortage could affect OEM production volumes, and thereby, the growth in sales volumes. Hence, Ind-Ra has revised down the expected sales volume growth in the PV segment to 15%-18% from 18%-22% for FY22. The chip shortage could affect the finished vehicle inventory levels in the next few months and lead to supply-side pressures during the festive season in 3Q. Already, the waiting time for some of the popular models exceeds three months. However, to manage the situation better, OEMs are keeping higher inventory at dealership level; PV inventory at dealers was 30-35 days as of end-July 2021.
Besides the increased raw material price scenario, the semiconductor chips shortage could affect the profitability of OEMs due to a) production disruption, and b) premium paid on procurement from existing/alternate suppliers to ensure adequate availability of semiconductor chips, and c) higher sales of non-premium models which do not require the chips in shortage. OEMs could consider price increases to meet the higher cost of production, partly shielding their profitability margins from the impact on account of the above outlined factors. Furthermore, Ind-Ra believes that OEMs could reassess their supply chains to diversify and/or partially localise these requirements over the near to medium term. Ind-Ra also expects OEMs to look at strategic investments so as to secure their supply chains, given the increasing usage of semiconductors in auto manufacturing.
Investments in Semiconductors Likely; Government Incentives Available: India is almost completely reliant on imports to meet its semiconductor chip requirements. The government, through the Scheme for Promotion of Manufacturing of Electronics Components and Semiconductors (2020) and the Production-Linked Incentive Schemes (2020-2021), has showcased a heightened focus on electronics manufacturing, including semiconductors. Ind-Ra expects these initiatives to lead to the creation of a favourable environment for wide-scale electronics manufacturing in India. However, semiconductor fabrication is a capital-intensive investment and the capacity requires almost two years to build-up. Hence, any investments are likely to aid local supply chains only over the medium to long term.
Impact on Global Auto Manufacturers in India: The semiconductor shortage is being faced across the globe by auto OEMs, since the beginning of 2021. Many global OEMs follow a centralised purchase policy, and have been focusing on efficient resource allocation to manage production. Hence, along with the allocation of chips to profitable models, more profitable geographies are being prioritised. Ind-Ra expects that global OEMs which have established diversified supply chains and higher inventory stocking policies are better placed in this scenario than those with concentrated supplies and/or larger reliance on just-in-time inventory management. As per Fitch Solutions Ltd, global vehicles sales are expected to return to growth of 12.0% yoy in 2021, following an estimated contraction of 14.5% yoy in 2020. However, sales volumes are expected to remain far below the pre-pandemic levels as the industry continues to face risks such as disruptions to the supply chain.
