 Budget 2006-07: Automobiles
After a highly fruitful FY04, the automobile industry managed to carry forward the momentum in FY05. While, FY04 was one of the best years for the Indian auto industry, FY05 was not far behind with growth being witnessed across all the segments. The industry benefited from another year of strong GDP growth (resulting in higher per-capita income), low interest rates regime and varied financing options. With government committed towards infrastructure spending and economic growth likely to remain strong, the automobile industry has the potential to register steady growth in the medium term. However, the exponential growth, similar to the previous two years, is difficult to come by as most of the pent up demand (of the period FY00 to FY03) appears to have been already filtered in FY04 and FY05. Further, rising fuel prices and hike in interest rates might throw a spanner in the wheels.Read more
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Agricultural lending target set at Rs 1,750 bn for FY07, an increase of 32.5%. One time grant to farmers who have availed loans from scheduled commercial banks, RRBs and PSCs for Kharif and Rabi 2005-06 of a principle amount upto Rs 0.1 m and interest rate of upto 2%. Short-term credit to farmers at 7% for loans upto Rs 0.3 m and 0.6 m hectors to be brought under irrigation in FY07.
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Excise duty on cars having engine capacity upto 1,200 cc (petrol based engines) and 1,500 cc (diesel based engines) and length of the car upto 4,000 mm reduced from 24% to 16%.
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Budget support for NHDP enhanced from Rs 93 bn to Rs 99 bn in 2006-07. Around 1,000 kms of access-controlled expressways (totalling six) to be developed on the BOT basis.
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Custom duty on alloy steel and non-ferrous (primary and secondary) metals reduced from 10% to 7.5%. Peak customs duty reduced from 15% to 12.5%.
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The continued focus on the agricultural sector (especially with respect to availability of funds to farmers) is likely to make more funds available for investment in farm mechanisation. Tractor manufacturers will benefit, considering the fact that around 51% of the cultivator houses do not have access to credit. It should be noted that more than 80% of the tractor sales are on credit.
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Reduction of duty of compact cars is likely to boost the demand for cars, as around 75% of the total passenger cars sold will fit in the criteria for exemption. Our calculation reveals that if the benefits of reduced prices are passed on to the consumer, retail prices could come down by around 5%. Similarly, there could be an incremental demand of around 7% to 10% due to the reduction.
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The continued thrust on the road infrastructure is a positive for the automobile industry in general and commercial vehicles in particular.
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The reduction in peak customs duty is likely to lower the cost of select components for auto majors. However, in the overall scheme of things, the benefit will be marginal in nature.
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Post the budget, our view on the auto industry has no changed and we continue to remain optimistic on the prospects of the industry from a long-term perspective. As far as the different automobile segments are concerned, we expect the two-wheeler segment to lead industry growth with a 15% CAGR from a medium term perspective. We base our premise on the fact that considering the low per capita income and the strong rural focus of the government, the demand for two-wheelers should continue to remain strong. We expect the passenger vehicle segment to grow at around 8% to 9% in the medium term, largely in line with the GDP growth. We expect the commercial vehicles segment to grow by around 6% CAGR in the next two to three years in the backdrop of the improvement in road infrastructure. Having said that, the recent restriction on overloading can provide additional upsides. However, higher interest rates and fuel prices could act as key barriers to growth, especially for commercial vehicles.
The operating margins of auto majors have been on the rise over the last three years and considering the increasing competition, we do not foresee significant improvements on other operating parameters barring the benefits arising from a reduction in steel prices.
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Key pre-budget memorandum for 2006-07 from Society of Indian Automobile Manufacturers (SIAM) is as follows:
Exise duty: Reduction in excise duty on passenger vehicles from the current level of 24% to 16%.
Customs duty: Increase the duty on both new as well as second hand imported CVs to 40% from the current 20%. However, status quo need to be maintained on import duties with regards to Passenger Cars/ MUVs. Customs duty on certain specific grades of raw materials should be brought down from the existing 10%-15% to 5% in order to improve the competitiveness of domestic automobile players.
Income tax: Reduction of surcharge of 10% under Income tax Act to Nil, reduction of distribution tax to 7.5% from the current level of 12.5% and wealth tax to Nil. Scrapping of fringe benefit tax. R&D benefit (of 150% deduction) under Income tax Act should be extended for further 10 years (it is expiring in March 2007). Increase in the depreciation rate from 15% to 25% for plant and machinery.
Sales tax: Introduction of uniform VAT system of taxation as it will reduce market distortions and enhance industry competitiveness. With the introduction of VAT, CST should be phased out since it enhances transaction costs and causes market distortions. Reducing the rate of VAT from 12.5% to 9%.
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| Budget 2003-04 |
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Budget 2004-05 |
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Budget 2005-06 |
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Excise Duty on passenger cars and UVs reduced from 32% to 24%.
Peak customs duty reduced from 30% to 25%.
Extension of R&D benefits.
Significant thrust on infrastructure development, especially roads. Concerted measures to boost the manufacturing sector.
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Deduction of 150% allowed on in-house R&D expenditure.
Tractors exempted fully from excise duties. Target of doubling agricultural credit in three years set.
Consortium of banks formed to ensure speedy conclusion of loan agreements and implementation of infrastructure projects.
Duty on non-alloy steel reduced from 15% to 10%. Duty on alloy steel and base metals also reduced from 20% to 15%.
Levy of 2% additional surcharge on corporate tax.
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Custom duty on second hand motorcars and motorcycles reduced to 100% as compared to 105% earlier. Custom duty on new cars maintained at 60%.
Excise duty on tractors of engine capacity more than 1800 cc for semi trailers to attract @ 16%.
Introduction of new income tax brackets.
Peak customs duty reduced from 20% to 15%.
Excise duty on tyres, tubes and flaps reduced from 24% to 16%. Customs duty on lead cut to 5%.
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| [Read more on Budget 2003-04] |
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[Read more on Budget 2004-05] |
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[Read more on Budget 2005-06] |
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| Key Positives |
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| Rising middle class: Expansion of population between the age group of 25 to 50 years, increasing affluence of the Indian middle class and heightened competition amongst automobile manufacturers, resulting in improved quality offerings, will continue to be the key drivers for the industry in terms of both market size and production capacities.
| Increasing exports: The Indian auto industry has emerged as an export hub, on account of its low cost technical manpower and increasing focus on quality. To give a perspective, in the last five years, volume exports of Indian automobiles has increased by 39% CAGR, led by passenger cars (CAGR of 62%). This development has led to domestic players increasing their share of exports in the overall pie.
| Infrastructure thrust: Improvement in road infrastructure has led to increased movement of goods through roadways. Around 65% of all the goods movement in the country takes place by roads as opposed to 55% a decade ago. Also, owing to the fact that an estimated 45% of CVs plying on the roads are 10 years old, demand for HCVs is expected to grow by a steady rate in the long term.
| Low interest rate regime: Close to 80% of the new vehicles being purchased in the country are financed, thus underlying the importance of a low interest rate regime to the fortunes of the industry. Though we believe that interest rates have bottomed out and are going to rise going forward, given that the quantum of the rise would not be significant, we expect the buoyancy in auto sales to continue over the medium term.
| Environment led benefits: Implementation of pollution norms like restriction on the age of the vehicle plying on the road and overloading of commercial vehicles would seemingly aid higher volume growth of this segment. However, we do not expect any significant increase in the demand in the medium term from this source, as in our opinion much of the replacement demand has already taken place.
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| Key Negatives |
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| GDP growth: The growth in per capita income over the last four decades (until 2002) in the country was slow, which had curtailed the growth of the auto industry since its performance is directly correlated to GDP. Though from a medium term perspective, the GDP growth is expected to remain strong, reforms need to be accelerated to sustain the current high GDP growth and the consequent growth of the auto sector.
| Competition from imports: With India coming under the WTO purview and the increasing free trade agreements (FTA), competition is expected to rise multifold. Indian companies also have to contend with imports in the future. Already a number of global auto companies are introducing vehicles through the completely knocked down (CKD) route.
| Taxation anomalies: Indian automobile industry is amongst the highly taxed industries as not only the final product bears heavy taxes but the cascading effect of duties on some key raw materials and components also hurts profit margins of auto companies. Also, multiple tax rules that exist in different states are eroding the comparative advantage of a large domestic market thus making the uniform implementation of VAT (Value Added Tax) necessary.
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