Fitch Ratings: Higher Fuel Costs Could Test Resilience of India ABS Transactions

Fitch Ratings-Hong Kong: Fitch Ratings believes that our rated Indian auto-loan ABS transactions will prove resilient to fuel costs at their current elevated levels. However, the greater the rise in fuel prices, the more of a challenge it will be for commercial vehicle operators to pass it on to their customers, and further large increases could have adverse effects on our rated transactions.

Our rated transactions comprise commercial-usage auto (truck) loans and tractor loans that are repaid mainly from earnings from the vehicles. Increases in fuel prices have a direct impact on the business models of vehicle owners, with fuel costs representing around half of operating expenses for truck operators, for example.

Oil prices have risen substantially in recent weeks, largely as a result of Russia’s invasion of Ukraine. As of March 2022, Fitch raised its forecast for average oil prices to USD100/bbl and USD80/bbl in 2022 and 2023, respectively, from USD70/bbl and USD60/bbl previously. India’s fuel prices, which are managed by the authorities, incorporate a base price that is intended to reflect the international cost of oil. Fuel prices were frozen between November 2021 and March 2022, and the excise duty on fuel was also cut in November 2021, by INR10/litre for diesel. These moves provided support to auto-loan performance, albeit without significant effects for our rated pools. However, since 22 March the cost of diesel has been raised by slightly more than 10%.

We expect vehicle owners to be able to pass on at least some of the increase in costs to their customers, particularly against a background of broader price pressures - consumer prices rose by 7% yoy in March, their fastest pace in 17 months. Robust growth in economic activity should meanwhile help to support earnings for commercial vehicle operators. We expect real GDP to increase by 8.5% in the fiscal year ending March 2023 (FY23). However, there is a possibility that higher fertiliser prices, which have also risen as a result of the Ukraine war, could weigh on rural economic activity.

Our baseline assumption is that increasing credit enhancement since closing should mitigate the risks posed to our rated auto-loan ABS transactions by the jump in fuel prices that we have seen in recent weeks, and that there will not be significant effects on ratings. Risks would increase if fuel prices were to rise more substantially. The adjustment in Indian diesel costs has not yet matched that in global oil prices. Brent crude prices rose by 32% in US dollar terms between 4 November 2021 (when Indian diesel prices were frozen) and 20 April 2022. Moreover, we expect the Indian rupee to depreciate by almost 5% against the -dollar in FY23, which would boost the increase in oil costs in local-currency terms.

Nonetheless, oil prices and fuel costs do not move in lockstep, and policymakers have options that could limit any future fuel-price increases. The authorities may opt to bear some of the cost of higher oil prices, for example, either through direct or indirect fiscal subsidies. They may also be able to negotiate supplies of oil from Russia at prices below prevailing global costs.

If fuel prices rise substantially, commercial vehicle operators in India could struggle to pass on the higher costs, resulting in margin erosion that could lead to higher delinquencies. Indirect effects would also increase, as higher fuel prices would begin to have a greater impact on economic activity. Under a hypothetical scenario in which oil prices spike to an average of USD150/barrel in 2022 and USD130/bbl in 2023, we believe delinquencies would rise significantly, with the potential for pressure on some transaction ratings.