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Tractor Industry: Agriculture dependence! - Views on News from Equitymaster
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Tractor Industry: Agriculture dependence!
Jun 14, 2005

The tractor industry has been on a growth trajectory since the second half of 2003-04, after going through a trough for 4 consecutive years. The key factors driving this growth are increasing farm incomes, aggressive financing resulting in easy availability of low-cost credit, sharp inventory correction and strong export growth. As the prospects of the tractor industry is directly related to the performance of the agricultural sector, we have analysed the reasons for the current status of the agricultural sector and where is the tractor industry is headed over the long term? Background: India is seventh in total area, second in arable area and first in irrigated area. The country accounts for around 10% of the global agricultural output. However, traditionally India is a low productivity and low mechanized country. The yield per hectare is among the lowest in the world. Just to put things in perspective, the yield per hectare grew at just 2% CAGR in last 20 years. Similarly only 40% of the gross sown area is under the coverage of irrigation.

Let us analyse the reasons for the same:

Minimum support prices (MSP): The system of procurement at assured price, buffer stocking and public distribution has locked up large resources (in terms of subsidies). This, in turn has affected public sector capital formation in agriculture. Apart from this, the concept of MSP, also affected the productivity of the farmers, as there were no triggers for them to improve the same. Secondly, due to this bias, the farmers were cultivating more of foodgrains and sugarcane thereby distorting arable land resources.

Lack of capital formation: Slowdown of investment in agriculture has impacted the pace and pattern of technological change. During the ten-year period spanning from 1993-94 to 2002-03, the ratio of gross capital formation in agriculture to real GDP originating in agriculture increased only by one percentage point from 6.1% to 7.1 %. This was mainly on account of the share of the public sector in gross capital formation in agriculture, which declined from 33 % in 1993-94 to 24.2 % in 2000-01. Decelerating public sector investment in agriculture, which goes primarily towards major irrigation projects, has also impeded adequate private sector investment in critical areas.

Excessive dependence on monsoon: The culmination of the above has been excessive dependence on monsoon for a good output. Traditionally, the fortunes of Indian agriculture (and hence tractor industry) have been dependent on the timeliness, quantum and spread (all three factors are equally important) of the monsoon. As can be seen from the chart there is a correlation between the performances of GDP, monsoon and the tractor industry.

Going forward…
While the dependence on the rain gods is expected to continue, the government’s thrust on developing rural economy, increasing rural credit flow, providing farm insurance, increasing the coverage of irrigated water, educating farmers on improving productivity and crop diversification and providing road connectivity augurs well for the agricultural sector and hence the tractor industry. However these are long-term structural drivers, which may not have significant impact in short to medium term.

Rising agricultural credit: Over the last few years, government has given significant thrust to agricultural credit flow. Traditionally, agricultural credit has been a risky affair with high percentage of NPAs, one of the primary reasons of commercial banks ignorance towards lending to this sector. With falling interest rates and increased focus of commercial banks towards rural credit, affordability in the hands of farmers will increase. This will be further aided by increasing thrust on farm insurance, which will provide some insulation in rough times. Just to put things in perspective the area coverage of farm insurance has reached to 271 lakh hectors in FY05 as compared to 7lakh hectors in FY00.

Increasing regional contribution: The new trend observed in this sector is the shift in consumption largely from the northern states to other parts of the country, too. With increased activities in eastern and southern region, we expect the demand for high-powered tractors to continue.

Replacement demand: Our calculations show that of the total tractors plying on the roads (around 30 m units), approximately 8 m tractors are more than 10 years old. Assuming a 10% to 15% replacement demand in the next 5 years, this could translate in to an approximate demand of 20,000 to 25,000 units per annum (8% of the industry sales in FY05).

Mechanization level-way to go: Although there has been satisfactory progress in agricultural mechanization in India, the availability of tractors in the country continues to be low (94 per 100 square kilometer of arable land) as compared with Malaysia (239 per 100 square kilometer of arable land) and Thailand (147 per 100 square kilometer of arable land).

To conclude…
With increasing awareness and improvement in rural infrastructure and taking into account the replacement demand, we expect the industry to grow in the region of 6% to 8% over the next 2 to 3 years with M&M being our preferred player in this segment.

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