Big Fuss about Small Cars

After reading yet another news article about the middle class dream, I decided to give this a thought. If and when Tatas, Suzuki, Hero Motors, Renault and others release their car with a 1 lakh ball park (~US$ 2000+) price tag, what will happen to the Indian auto market? The market is huge, no question about it. India adds an equivalent of a Malaysia or a Thailand every year to its middle class population. But is this a good development? I wouldn’t say so.

The price elasticity for a car is 1.8 which means that a 10% drop in prices could lead to an 18% surge in demand. If the small cars come to market, there is a fear that other manufacturers could cut prices by 10-15% straight away leading to an increase of 18-22% in demand. Cheaper cars would also eat up a significant portion of the two-wheeler and three-wheeler market. Today, cars make up about 15% of the total vehicular population and two-wheelers make up close to 70% of the total. With the advent of cheaper cars, I foresee that the total vehicular population will increase at least 15% in just one year with the percentage of cars going up from 15% to 22% of total in just one year!

In addition to the large burden that these cars will place on the crumbling infrastructure, it will also place a large burden on the energy resources. Vehicles currently take up one third of the total petroleum needs of India (with a 70% two wheeler population and 15% car population). The energy needs of a 15-20% higher vehicular population (with lesser bikes and more cars) will be much higher. Energy needs of India as a whole will increase 5-10% thereby impacting petroleum prices. Remember, this is for one year and the car penetration is currently about 0.85% in India. If the penetration grows steadily, aided by price reduction and growth in disposable income and starts looking like Malaysia’s 18%, it will be time for a second emergency!! :)

Unfortunately, I couldn’t get hold of the demand elasticity for petroleum in India. For now, it suffices to say that petrol prices will certainly move northward with increase in car numbers thereby increasing the variable costs of owning a car. We haven’t even considered other variable costs like parking charges, tolls which will also increase due to market effects.

That brings us back to square one! I am sure every middle class family will own a car, but will not be able to afford to use it daily. The manufacturers and the government (which takes 30% of the car price as taxes) will make a killing and we, the middle class, die!