Do capital goods firms have a bleak future? - Views on News from Equitymaster

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Do capital goods firms have a bleak future?

May 21, 2013

The issue of import duty on power equipments had been lingering since many years. Finally, the government took notice of the plight of domestic manufacturers. It approved imposition of 21% duty on imported power equipments in July 2012. This will include 5% basic import duty on power generation equipments. Also, 12% countervailing duty (CVD) and 4% special additional duty (SAD) is likely to be levied.

The domestic manufacturers have long been struggling with lack of orders and delay in execution due to poor health of the power sector On top of this, influx of cheaper imports particularly Chinese has made matters worse for the domestic companies.

Reason for the relaxed terms on duty earlier

For power plants of above 1,000 MW there is no import duty, while plants below 1,000 MW attract a 5% import duty.

We believe; relaxation of import duty was a necessity in earlier years of capacity expansion i.e. 10th and 11th plan. At that time, the domestic manufacturers did not have expertise and capacity for super critical equipments. However, once the domestic manufacturers started setting up super critical facilities; it was time to increase the import duty. This was essential to get a level playing field with Chinese competitors. This is because manufacturers from countries like China and Korea enjoy various benefits. These benefits range from large scale manufacturing, low interest rates, easy procurement of loans to an undervalued currency. Such cost benefits make Chinese equipments relatively cheaper as compared to their Indian counterparts. Typically, the cost to set up a power plant is Rs.50-55 m/MW. Chinese manufacturers, however, are able to quote as low as Rs. 45 m/MW. Clearly Indian firms have a price disadvantage of about 15-20%.

The following could be likely implications of duty in our view

  • The import duty will be levied on a prospective basis. Hence it is not expected to impact power projects for which equipment orders have already been placed. The Boiler, Turbine and Generator (BTG) orders for 12th plan (2012-17) have already been placed. And for the 13th plan (2017-2022), orders will start after 2-3 years. So there will not be an immediate uptick in demand.

  • The kind of products/ components that will come under the duty’s purview need to be known. This is crucial because domestic manufacturers also import certain power equipments and components. Hence, import duty may in turn increase manufacturing cost for domestic companies as well.

  • The expected capacity for boilers is 31,000 MW; while for TG sets it is 36,000 MW. On an average, the demand for BTG may not be more than 20,000MW per annum. Hence, capacity may exceed the demand. This may induce price war amongst foreign and domestic firms. We fear over capacity may negate the positive effect of import duty.

  • The duty’s impact will be seen on China’s Indian customers too. These customers are largely private power developers such as Reliance Power , Lanco Infratech and Adani Power. Any rise in the cost of the equipment may lead to higher power tariffs.

  • On the contrary, Chinese and Korean manufacturers have already begun setting shops in India. This will help them avert the impact of duty to a certain extent.

Conclusion

We expect that imposition of import duty may make import (largely Chinese) costlier by at least 5-6%. This difference excludes foreign exchange impact. While we welcome this move, it has come in to implementation too late. Enough damage has been done in the 11th plan and 12th plans where domestic companies lost out in a big way to foreign players. In addition, the demand for power equipments will continue to be bogged down by other existing issues like coal linkages, land acquisition and environmental clearances. Therefore, in our view, duty has been imposed too late and perhaps, cannot do much to push the domestic equipment industry.

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