BMI View : Given that the latest increases in Sri Lankan auto tariffs disproportionately target Indian vehicle imports, we see them as further exacerbating the domestic problems of Indian automakers, as they already face a slowdown in their domestic market. We maintain the need for long-term reforms in the Sri Lankan auto sector as the viable way to encourage domestic production in the country. With the significant amount of trade between the two countries, we believe a win-win solution will soon materialise, and consider a trade war to be the bear case scenario.
Indian auto companies, which are already facing a slowdown in their home market, have been dealt another blow with Sri Lanka announcing a steep increase in indirect levies on auto imports. Indian vehicles account for about 95% of the Sri Lankan auto market and the latest tariffs are going to render them extremely uncompetitive.
While the latest tariffs do not target Indian vehicle imports per se, the category of vehicles for which they have been increased, could be seen as targeting them indirectly. The huge increase in duties on utility vehicles, two-wheelers and small cars, will hurt the Indian auto industry badly, given that these form a large portion of the auto exports to Sri Lanka. In contrast, second hand cars from Japan and Singapore are not affected by these incremental levies and we believe they will grab market share from Indian brands, should the status quo continue.
|Just Tax Them|
|Sri Lanka- Excise Duty On Imported Vehicles (LHS); Total Duty On Small Cars (RHS)|
Furthermore, we see the latest round of tariff increases as exacerbating the problems of the Indian auto industry. From 2011-2012, India's exports to Sri Lanka, its largest auto export market, accounted for US$800mn, about 13% of its US$6bn global auto exports. Latest announcements from the Society of Indian Automobile Manufacturers (SIAM) have indicated that Indian auto exports to Sri Lanka have virtually ceased. This would further affect the growth prospects of Indian auto companies, given that they are already experiencing a slowdown in their domestic market.
In our opinion, one possible reason for the rise in levies could be to use them as a source of revenue for the government. The Sri Lankan government has been running budget deficits for the past few years and the government's forecast for the 2012 budget is a deficit of 6.2% of GDP. With a debt-to-GDP ratio exceeding 80%, the Sri Lankan government has been trying to find new sources of revenue to get its fiscal house in order.
While these tariffs could have also been raised to induce foreign automakers to produce in Sri Lanka, given that the country does not have large-scale local car production of its own ( see our online piece, November 19, 'Latest Budget Could Induce Greater Local Production'), we do not see the charges as sustainable, given that they target the Indian auto industry in such a disproportionate manner. The fall in domestic Sri Lankan auto sales as a result of these policies will have headwind effects on economic growth.
We see strong reforms in the auto sector as the only viable long-term measure to boost the Sri Lankan auto industry. Tax reforms, manufacturing incentives, as well as an educated workforce are some the measures which the Sri Lankan government needs to take, to encourage global automakers as well as component makers to increase their investments in the country and spur local vehicle production.
Bear-Case Scenario (Trade War)
To be sure, we cannot rule out a tit-for-tat move by the Indian government in the near future should the Sri Lankan government refuse to remove or reduce the tariffs, which could then see an escalation of this issue into a trade war between the two countries.
|Neighbourly Trade On The Rise|
|Sri Lankan Trade With India, US$mn|
Cross-border trade between the two countries has been increasing and Sri Lankan 2011 exports to India totalled roughly US$524mn. Moreover, Sri Lanka imports a significant amount of goods and services from India, totalling US$4.34bn, in 2011. Should the Indian government decide to engage in a tit-for-tat strategy and slap tariffs on Sri Lankan exports into India, we believe the broader Sri Lankan economy could be hit badly.
With SIAM and other Indian trade bodies trying to engage in high-level diplomatic discussions to try and find a solution soon, we expect a compromise to materialise in the near future. However, should the Sri Lankan government refuse to budge on the tariffs and/or the worst case scenario of a trade war materialises, we may be forced to revise our forecast for Indian auto production.