With global economic slowdown looming on the horizon and Indian economic growth coming under a cloud of uncertainty, the auto industry in the country has no reason to rejoice. For the Indian auto industry, the domestic market becomes all the most important at such a time. But with the manufacturing sector losing pace and the service sector coming under pressure, the auto industry has already taken a severe beating in the last couple of months.

Interestingly, there is something strikingly similar between steel and passenger car industries in India. Each of these industry added capacities mindlessly. Although certain technological factors and the need to achieve economies of scale were responsible for quantum jumps in new capacities, the main factors were some wild forecasts of rapid expansion of markets of these products in India, as also globally, and relatively easy availability of funds in the mid-nineties as reforms were pressed into the country's economic system.

Both these industries were under strict government regulation. Restricted entry had created in both a syndrome of apparent shortage. Buyers had to queue up for the product. This is characteristic of a sellers' market. It was believed that the real demand for steel and passenger cars in the country was far more than what the industry could perhaps deliver at full capacity. The difference was that in the case of passenger cars, the buyers were assumed not to have received the real value for money. Shoddy products were on offer at monopoly prices. Technologies of '50s continued to survive with government patronage. In steel, it was believed that the regulated prices were far below the market prices. The problem of quality was present but not considered primary. Both  industries are in deep trouble now.

Let me take the passenger car segment. According to generally available statistics, the production capacity in the passenger car industry in India is going to be twice as much as the demand. The recent ICRA report has predicted that the market for mid size cars is heating up and, possibly, will lead to some shake out soon. There are too many players chasing too few customers. In the mid size, Rs. 4.5-7 lakh category, cars that ICRA perhaps talks about include Nexia and Cielo of Daewoo, Accent of Hyundai, Esteem and Baleno of Maruti, Corsa of GM, Ikon of Ford, Siena of Fiat - I hope I have not left any other model out. In the slightly higher range, there is the Lancer of Hindustan Motors, Astra of GM and City of Honda and of course the Merc. In a typically developed country market, there may be a larger number of models but fewer companies in business.

The market is no less congested for the small car segment. Apart from the several models of Maruti Suzuki (Maruti 800, Alto 800 and 1100, Zen and Wagon R), the market has a strong presence with the Santro, Matiz and Indica with some small competition from Fiat Uno.

Here also, the industry forecasts were far on the higher side. Is it that as with steel, the passenger car industry has not accurately read the market? Or is it that they are guided by other considerations?  Or, is there a system failure here also?

Let me start with some relatively simple issues. The small cars have seen the largest capacity growth. None of the major players perhaps had realised that the purchasing power of the population was not so high as to easily afford a car at the prices these are being sold. The huge growth of car financing, increased salaries of the government employees and the booming IT sector wages nevertheless sustained the urban craze for new cars. But at the final count, the number itself was far too small to support the kind of capacity that had been built up. The sales will not justify the kind of investments each of these companies has made.

Car makers seem to be totally carried away by the possible growth in personal income to forecast demand for cars. Although the number of people who can actually afford to have a car at the kind of prices prevailing now is still very low, the potential is very large. The number of people willing to own a car, used or new, with their income falling short marginally (even considering the financing, as the installment payments may be fairly large) can be very large. The problem is with huge duties on passenger cars, car prices could not be brought within the range of real affordability. Even a small car price may be several months' earnings of a salaried person, if not a year or two. The problem is with even Maruti 800 gaining value and price, many who could at times think of buying this small car are waiting for their fortunes to turn around to be able to buy one such or a better model in the market.

There may be new demand in the smaller towns, where there is much money, but to provide adequate and sustainable infrastructure, car manufacturers will require huge investments, that may not prove worthwhile considering the expected gains from it. In small towns, people are still content with older generation vehicles (which even today fetch high second hand prices.) The problem is that the potential customer base is so evenly spread out that car manufacturers concentrate on larger markets like metros making the situation tougher for them and making competition among themselves stronger.

Cut-throat competition led the car makers to literally sell below production costs (this is based on a newspaper report. Perhaps true - if financial costs are considered even for the most efficient car makers. Others may be losing even cash.) It is said no small car maker makes money at the current prices. There is no large takers for these cars at higher prices. Globally, the auto industry is highly concentrated and it has been estimated that five auto giants control over 80 per cent of the market. In India, a small market, there were already five major players, with absolutely new investments.

This rather familiar story, true for many other industries in the country, was also the result of surplus manufacturing capacities of capital goods globally and easy availability of public funds for investment in mid '90s. With specific investment costs on the downhill, most entrepreneurs had to convince some bankers and financial institutions of the viability of projects on the basis of some common statistics and expert reports. So strong was their conviction (as also of the convinced bankers) that the car makers agreed to even tough conditions like export obligations and indigenisation, most of which they want to get rid of now.

As happens in any large project, if capacity is not fully utilised and the companies run into financial trouble,the industry becomes a drag on the financial system with blocked investment funds. It is not just the amount invested in such projects before the companies fall sick. The problem is, with such large exposures, financial institutions and banks run into a credit trap, finding it necessary to loan more and more on weaker terms merely to keep the company afloat and in the process, keep its volume of non performing assets low.

Could car makers or the government think of alternative tracks for developing the industry in the country. We are already stuck with huge investments, much of which may go waste in various ways. What is pretty certain is that the government could have opened the small car segment much earlier. Although that would have broken the monopoly of Maruti and the consumers perhaps could have got a better deal, in terms of both quality and price, a more competitive market as today's would have created problems no different. The only factor that would have been in its favour was that public money was not so abundant a decade ago. Therefore, only the more serious ones would have made the grades.

The government should have cut its role in the auto sector earlier and also perhaps not insisted on strong conditions like indigenisation and export obligation. The government should have reduced import duties on capital goods in general and if needed, abolished it completely from those required for the auto industry. The fear was that the Indian industry in its absence would have turned into an assembly line with all kinds of cars churned out bringing the industry to a ridiculous state. These are problems more specific in the Indian context and to cope with it the government resorted to such apparently irrational measures. The government apprehension in many cases has been vindicated. Therefore, it is also an industry problem - to be unable to work straight and end up accepting all kinds of stringent conditions to make immediate gains.

The other important issue is that in a globally integrated market, one produces for the global market. Was the  passenger car a product that could be produced in India globally ? However good a car is, a Matiz or a Santro, marketing that product worldwide is challenging and costly. Therefore, car manufacturers have resorted to only piecemeal exports merely to complete export obligations. Interestingly, it has been reported that Ford can perhaps break even at a production of about 40,000 Ikons. The domestic sales are in the range of about 20,000 now. Therefore, they will have to export 20,000. Although the company claims that it has firm export orders as CKD kits, a fuller foray into the world market is still a far cry and they do not seem to be heading towards global operation from India as yet.

The car industry will have to get restructured. Daewoo bankruptcy will trigger one such process. There are already talks of the company being taken over by General Motors. Good if that happens. There were also news of Telco scouting for a buyer or a partner to take over Indica. The government has decided also to offload its stakes in Maruti. The process seems to have begun.

Before the economic conditions turn worse, the government may need to review its policy on the auto industry.