Sector Update
23 March 2013

Capital Goods

     
 
 
Economic Slowdown & Cheaper Imports likely to keep CG industry under pressure…

The Capital Goods (CG) industry plays an important role in the development of the country and its economy, It is considered as a strategic sector for the expansion of national capabilities, which are essential for a national self-reliance and security perspective. The capital goods industry is the mother of all manufacturing industry as it facilitates faster growth for a broad base of user industries by providing critical inputs, i.e. machinery and equipment necessary for manufacturing. The Indian capital goods industry has entered into the new development phase since March 2002, due to investments having taken place in the power sector, infrastructure, oil & gas sector, steel plants and automobile industries etc. The capital goods industry contributes 12% of the total manufacturing activity, which is about 1.8% of the GDP. The industry currently employs over 1.5 million skilled and semi-skilled workers. Foreign Direct Investment (FDI) up to 100% permitted through the automatic route in this sector.

 

Industry Segments
The CG industry in India is broadly divided into 9 categories including Heavy Electrical Equipment, Engineering Goods, Process Plant Equipment, Earth Moving Equipment, Dies, Moulds and Tools, Textile Machinery, Machine Tools, Metallurgical Machinery and Plastic Processing Machinery. Among these sub-sectors, Heavy Electrical Equipment and Engineering Goods are the largest and fastest growing sub-sectors with a market size of over Rs 1,21,000 crore and 1,16,000 crore and both constitute around 40% share of the total output of the sector. While, the remaining sub-sectors represent a low share in production, they account less than 10% of total production.


 
INDUSTRY PERFORMANCE
 

Economic Slowdown & cheaper imports declined growth 4% in FY12…
In the last five years, the output of capital goods increased at average growth rate of 14.9%. As the capital goods industry is sensitive to the economy and due to the prevailing economic slowdown it has recorded lowest growth at (-4)% in the FY12. During the FY12, the pressure on this sector output was primarily due to the economic slowdown leading to sluggish domestic industrial growth. The slowdown in infrastructure as well as key user industries has strained the industry players with slowdown in order inflow, delay in taking deliveries/execution of projects and delayed bill payments etc. Further, the surge in cheaper capital goods import was also partly responsible for the decline in production growth in FY12, as the use of second high machinery is high in certain sectors.

 
 
CURRENT SCENARIO
 

Growth has been declining during the first nine months of FY13…
CG sector is highly correlated with the fluctuation in the business cycle as it relies heavily on manufacturing. The sector performs well, when the economy is expanding as more projects come in, leading to more order for the sector. Presently, Indian economy is struggling with slowdown and the capital goods output growth has declined. As per use-based classification, in Apr-Dec FY13, the capital goods production declined by 10.1% as compared to (-) 2.9% growth in the same period of corresponding year. Month wise, barring October, this sector has witnessed negative growth during the first nine months of the FY13.

 

Currently a major concern for this industry is the slowing down of ordering activity because of the economic slowdown, which has highly impacted the manufacturing activities across the country. On the supply side, industry's output determines its investment scenario. From the past one year, the prevailing economic slowdown has lowered the investment into the sector, but this time it is also facing some of the structural issues on the supply side as uncertainty in coal supply and losses of state electricity boards (SEBs) have made banks weary for lending to the sector.

 
 
IMPORT & EXPORT
 

Cheaper & Technically more advanced Equipments attracted 30% Imports…
Over the past few years rising trend of capital goods import has become an issue for the industry. Imports presently address 30% of domestic demand for capital goods with the proportion being significantly higher in the critical components segment for each sub-sector. Capital goods import has increased by 16% average growth rate over the past five years due to the cheaper import as under the free trade agreement, finished machinery is imported at a lower rate of import duty.


Meanwhile, industrial products are not technologically advanced as compared to the global players; also the high factor cost has raised the price of the capital good products, which led to the surge in import. Moreover, the free import of second-hand capital goods without considering the age factor has also been contributing to the increase in import of the capital goods. The domestic industry is reeling under pressure from cheaper import as import prices of second hand capital goods are par or below the fresh one manufactured here. On the other hand, export of capital goods remained under pressure in FY12 due to the sluggish output growth along with the global economic slowdown, which has slowed down the manufacturing activities globally. In FY12, Indian exports of capital goods increased by 8% on YoY basis as compared to 25% growth registered in the previous financial year.

 
 
 

CONCERNING FACTORS FOR THE CAPITAL GOODS INDUSTRY

Increasing Import put pressure on Production Growth...
The sub-sectors of CG, which constitute highest share in imports, also represent lowest share in domestic industry production. The increasing dependence on imports for these sub-sectors is the major reason for their lowest share in total output of the industry. The sub-sectors, whose demands are mainly relying on external import, are machine tools, metallurgical machinery and plastic processing machinery. On the other hand, domestic demands of the two major sub-sectors of the industry include heavy electrical equipment and engineering goods segments are largely fulfilled by the domestic production.

High Factor Cost
Domestic manufacturers have been bearing higher cost structure compared to the global peers. The reasons range from higher factor cost of power, taxation, delay in land acquisition and lending to inefficiencies in manufacturing process dispersed supply chains, duplications of facilities and lack of standardization. However, labour costs are competitive in relation to the other developing economies, but the productivity itself has not been growing at a comparable rate from the past four years.

Mounting pressure of Cheaper Imports
The rising trend of capital goods import has become a major concern for the industry. Due to the high cost of manufacturing, the import prices of second hand capital goods are par or below the fresh one manufactured in our country. At the same time, import duty on finished cost is lower, thereby creating an advantage for import over domestic products. Further, free trade agreement (FTA) is also creating undue advantages for global player seeking to tap into Indian demand. So, the industry needs favorable policies for creating a level playing field to global competitors.

 

Tax Structure & Locational Disadvantage
The existing tax structures, duties and regulations are not favorable for the industry as they are imposing higher cost on domestic manufactures. Further, the state wise difference in overall tax and duty structure are also affecting the domestic manufacturers. Apart from these, location of the manufactures are also affecting the production of CG sector, as most of the domestic production plants are located far from their suppliers, which has increased their dependence on the supply chains. Thus, high logistic cost has raised the overall cost of manufacturing.

 
 
 
Government Initiatives to support the Capital Goods Industry
 

Outlay of Rs. 23 billion has been proposed for Heavy Industry in 12th five year plan..
Capital Goods sector is one of the most focused sectors for the Govt, government has formulated a manufacturing plan in the 12th five year plan (2012-2017) and under which capital goods is one of the focused sectors. The plan proposes policies and technology support to the industry with a view to provide a level playing field to domestic manufacturing in comparison with global players and also aims to enhance growth, global competitiveness and reduction in import dependence. The government has also set up a Development Council for important sub-sectors of the industry include textile machines, heavy electrical equipment and machine tools. Further, the proposed manufacturing plan also envisages common facility centres, and product development centres in and around capital good industrial clusters. A scheme with an outlay of Rs. 2,360 crore has been proposed by the Department of Heavy Industry for the 12th five year plan. The scheme also focuses on R&D and technology support, common facility support, skill development and interest subvention.

Union Budget 2013-14 proposed various considerable measures for the sector...
The government in the Union Budget 2013-14 has proposed various measures for the sector. The government proposed the investment allowance of 15% on investment of Rs 100 crore or more during 1/4/2013 to 31/3/2015 in plant and machinery (additional) apart from depreciation. Also, there was declaration of providing Rs 1,400 crore for setting up of water purification plants in 2000 arsenic-and 12000 fluoride-affected rural habitations. However, the major boost to the sector is going to be the allocation for Defence, which was increased to Rs 2,03,672 crore including Rs 86,741 crore for capital expenditure, which includes modernisation related expenditure. The government also proposed that state governments should prepare the financial restructuring plans for state power distribution companies, though there were no specifications about any allocation. From the budget announcements of 15% investment allowance on investment of Rs 100 crore, the industry will get a tax benefit for the selected period. While, the increased allocation for Defence will open a door of opportunity for the capital goods sector.


GROWTH DRIVERS

India, A Fastest Growing Economy ...
Indian economy is one of the fastest growing markets in the world. The surge in local demand provides a huge opportunity for the Indian capital goods sector to scale up. It is also expected that the industry will do significant collaboration with end user industries in the future to fully leverage this demand to the sector's advantage.

Proposed Significant Investments for Industry...
In the 12th five year plan, the government has proposed policies and technology support for the industry, leading to the high standardized products. Moreover, the plan has also set a high growth target for Indian manufacturing industry and will mainly focus on the CG sector. At the same time, domestic manufacturers were also encouraged to think of ways in which they can acquire technology to compete against cutting edge products from foreign players. This will promote greater investment in R&D and also improve the practices for rapid adoption of new technology made available through JV and global acquisitions to plug gaps in their technology portfolio. Growth in the industry is also supported by a large number of projects that are expected to be commissioned in the 12th plan, requiring a significant expansion of the sector. E.g. the Planning Commission has set a target of adding 70-80,000 MW of power generation capacity in 12th plan, which will drive a strong demand for heavy electrical equipments.


OUTLOOK

Production likely to remain under pressure but in the long term, expected to revive...
Manufacturing sector creates major portion of demand for the capital goods industry. The industry is highly sensitive to economy, has primary importance for the growth of manufacturing in India, as it constitutes 12% of the total manufacturing activities. However, the share of manufacturing sector to GDP is still low when compared to the other developing countries reflecting a significant upside for manufacturing sector in the future, which is positive for the capital goods industry.

However, the prevailing economic slowdown has impacted the domestic manufacturing activities and has lowered the industry output with slow order inflow. In the near term, the production of industry is expected to remain under pressure because the recovery in industrial capital expenditure looks constrained and pointing towards the tough environment for order inflows to the Indian capital goods sector.

During the past few years, industry has been struggling with the high factor cost and low investment in research and technology leading to surge in capital goods import, which has become a concern for industrial production growth. However, in the long term, the industrial production is expected to increase with the implementation of 12th five year plan as it will focus on some critical issues of industry like R&D and supportive policies. Moreover, the increase in industrial output will also reduce the end user industries dependence on import.

 
 
 

Key Financials - Capital Goods Industry

 

NAME
DESIGNATION
E-MAIL
Varun Gupta
Head - Research
Pashupati Nath Jha
Research Analyst
Vikram Singh
Research Analyst
 
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