Auto to ride on Budget sops

FY04 turned out to be one of the best years for the Indian auto industry. Attractive finance schemes and buoyant economic growth helped both the passenger and commercial vehicle industry notch up growth in excess of 30%. With government committed to continue with infrastructure spending and economic growth likely to remain robust the industry seems to be headed in the right direction. However, rising fuel prices and hike in interest rates might throw a spanner in the wheels.

Budget Measures

	Deduction of 150% allowed on in house R&D expenditure.
	Excise duties on tractors to be fully exempt.
	Target of doubling the agricultural credit in three years.
	Consortium of banks formed to ensure speedy conclusion of loan agreements and implementation of infrastructure projects.
	Duty on non-alloy steel to be reduced from 15% to 10%. Duty on alloy steel and base metals to be also reduced from 20% to 15%.
	Levy of 2% additional surcharge on corporate tax.

Budget Impact

	Tractor manufacturers will benefit from increased demand for tractors once they pass on the benefits of excise duty exemption to the end consumers. The industry has just come out of a three-year slump, having registered a volume growth of 10% in FY04. Thus, the current exemption is likely to give a further boost to demand. The target of doubling the agricultural credit in three years is also likely to make more funds available to the farmers for investment in farm mechanisation.
	With major auto companies spending sizeable amount on product development and in-house R&D expenditure in recent times, deduction of 150% allowed on the same will encourage further R&D investments. With cost efficiency no longer the domain of any single player, future survival will depend upon the capability to offer more technologically competent products. From this perspective, the current move is a step in the right direction.
	The government has pushed for speedy implementation of infrastructure projects, which is a good sign for the auto industry, especially the CV manufacturers. In line with the international experience, improvement in road infrastructure will translate into increased demand for higher tonnage CVs.

Sector Outlook

In view of a couple of positive measures such as the excise duty exemption on tractors and 150% deduction on R&D expenditure, we remain positive on the future prospects of the industry. Also, with government pressing for improvement in road infrastructure, the position of railways as the main carriers of goods such as food grains and cement has come under significant threat. On the two-wheeler industry front, since most manufacturers have a technology tie-up with a foreign major, the incentive to do R&D with the Indian counterpart has increased. Since operating margins of auto majors have increased over the last three years, significant further improvement from the current level is limited and to that extent, we remain cautious.

Industry Wish List

Key pre-budget memorandum for 2004-05 from Society of Indian Automobile Manufacturers (SIAM) is as follows::
	Reduction in excise duty on passenger cars and passenger vehicles from the current level of 24% to 16%. Duty on imported CVs to be increased to 40% for both new as well as second hand vehicles from the current 20%. However, status quo to be maintained on duties with regards to Passenger Cars/ MUVs and Passenger 3-wheelers
	Abolishing the surcharge levy as it is only a temporary levy and reduction in corporate income tax from 35% to 30% and dividend distribution tax from 12.5% to 7.5%, in line with the Kelkar committee recommendations.
	Customs duty on certain specific grades of raw materials like CR steel, HR steel, Alloy Steel should be brought down from the existing 15% to 10% as these are not available in India due to low volume and quality limitations.
	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.
	Increasing allocation from automotive cess fund for R&D activities and incentivising fleet retirement programme. This would not only address pollution from in-use vehicles but will also reduce fuel savings, as new vehicles are more fuel-efficient than the older ones.

Budget over the years

Budget 2001-02	Budget 2002-03	Budget 2003-04

Thrust on infrastructure spending. Withdrawal of special excise duty of 8% on two-wheelers and cars. Import of second hand vehicles permitted at 105% with effective duty at 180%. Accelerated depreciation of 50% of new CVs for the first year.	Peak customs duty reduced to 30% from 35%. Dereservation of 50 items of select components that fall under the SSI sector. Administered interest rates lowered by 50 basis points. Special excise duty on passenger car sales, MUVs and tyres retained. Petrol and diesel prices reduced.	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.

Key Positives

	Middle class story: Increasing affluence of the Indian middle class and introduction of better quality cars has led to strong growth in the industry in terms of both market size and production capacities.
	Exports buoyancy: On account of its low cost technical manpower and ever increasing focus on quality, the auto industry has emerged as an export hub, especially for the compact car segment. Exports of passenger cars from the country have increased at a healthy CAGR of nearly 38% during the past five years and increasingly more and more auto majors are lining up to set up their production bases in the country.
	Infrastructure thrust: Improvement in road infrastructure has led to increased movement of goods through roadways. Close to 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 39% of CVs plying on the roads are 10 years old, demand for HCVs is expected to grow by a robust rate in the long term.
	Low interest rate regime: Close to 80% of the new cars being purchased in the country are financed, thus underlying the importance of a low interest rate regime to the fortunes of the industry. Given that interest rates are unlikely to rise at a rapid rate in the future, we expect the buoyancy in auto sales to continue over the medium to long term.
	Environment led benefits: Any implementation of pollution norms in metros, whereby vehicles beyond certain age need to be phased out could further translate into higher volume growth for all vehicles, courtesy the replacement demand.

Key Negatives

	Concerning income growth: The per capita income in the country has been growing at a slow rate. Since the auto industry growth has a strong correlation with the same, the momentum has to continue to ensure robust automobiles demand. Reforms need to be accelerated.
	Competition from imports: With India coming under the WTO purview, competition is expected to rise multifold. Indian companies also have to contend with imports in the future. Already a number of companies are introducing vehicles in the CKD route.
	Taxation anomalies: Duties on some select and key raw materials including steel and components are still pretty high and are thus hurting profit margins of the companies. Also, multiple tax rules that exist in different states are eroding the comparative advantage of a large domestic market thus making it important to implement VAT (Value Added Tax) as soon as possible

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