RAMA
Air-conditioning & Refrigeration
Industry
Pre - Budget Memorandum
2003-04
13 December 2002, New Delhi
SUMMARY OF KEY MESSAGES- AIR-CONDITIONERS, 1
RAMA
• The Indian AC market size is Rs 2,790 crore comprising the household and commercial
segments. The market is currently at a nascent stage and shows tremendous promise to
grow. However, despite the reasonable growth in the last few years, the growth potential has
not been entirely captured.
• The key bottleneck to growth is the low affordability of ACs. This is clearly evidenced in the
Chinese market where substantially low price points (less than 50% of Indian retail prices)
have driven penetration of ACs.
• In order to capture the growth potential, a substantial reduction in price is required. The
primary cause for the high prices is the high incidence of indirect taxes, excise duties and
import duties on the product category : accounting for close to 45% of the MRP. In particular,
the abnormally high excise duty of 32% is a major deterrent to growth.
• With government support in duty and tax rationalization, the AC market can grow very rapidly
over the next 5 years to as much as Rs. 14,000 crores by 2007. Reducing excise duties,
indirect taxes and import duties is a win-win-win solution for the government, players and
consumers.
• The specific short term proposals include:
– A reduction in excise duty from 32% to 16% with 40% abatement beginning March ‘03
– Excise exemption in certain states such as Jammu, North East to be repealed as they destroy
value for government, players and consumers and confer none of the intended benefits to the
system
– A reduction of import duty to 25% for finished goods and 15% for components beginning Mar-03
1
RAMA
SUMMARY OF KEY MESSAGES - COLD CHAIN, 2
• Agriculture has been recognised by government as a focus area
• Cold chains (84.18) are a vital part of the agricultural chain
• There is a huge unrealised potential for
–
–
–
Preserving food and dairy products
Improving food distribution
Reducing cost of food to the common man
• Cold chain enjoy excise exemption. however, CENVAT credit on inputs is not
available
• To maintain the spirit of exemption from incidence of taxes, replace exemption
to cold chain by refund/ subsidy
2
RAMA
THE INDIAN AIR-CONDITIONING INDUSTRY IS A
Rs 2,790 CRORE MARKET
Segment
1
Window ACs
Value
Volume
Applications
Rs 1200
crore
540k nos
Homes, SOHO
Major players
2
Mini Split ACs
Rs 730
crore
220k nos
Homes, offices,
shops, showrooms
3
Ducted Split
and
Packaged AC
Rs 400
crore
216k tons
Commercial
establishments
4
Chillers and
Central Plant
Rs 460
crore
272k tons
Industrial,
institutional and
large commercial
• Amtrex Hitachi
• Blue Star
• Carrier Aircon
• Daikan Shriram
• LG
• Samsung
• Voltas
• Whirlpool
• O’General
• Matsushita
Rs 2,790
crore
Industry investment in line with potential resulting in surplus
capacity leading to oversupply and price wars
Source: Francis Kanoi; Industry estimates
3
RAMA
THE RESIDENTIAL SEGMENT IS FAST OVERTAKING THE
COMMERCIAL SEGMENT IN RAC WHILE THE PACKAGED AC HAS
WITNESSED LIVELY GROWTH IN RECENT PAST
Increasing share of domestic segment in RAC
Packaged AC displays, thrice the
growth of GDP
90
‘000 Tons
80
Estimates
Commercial
215
14%
70
185
165
60
Actual
141
50
110
40
123
30
20
10
Residential
0
'92- '93- '94- '95- '96- '97- '98- '99- '00- '01- '02- '03- '04- '0593 94 95 96 97 98 99 00 01 02 03 04 05 06
• Growth of residential segment driven by higher affordability and
•
disposable income, changing lifestyle in perceiving AC as need
rather than luxury
Residential segment expected to drive growth of RAC &
eventually will increase share >80% as in the most markets
Source: Francis Kanoi; Industry estimates
'97-98
'98-99
'99-00
'00-01
'01-02
'02-03
• Easy Availability of comprehensive range
of ducted splits and ductless flexible PAC
system & improved affordability will drive
future growth on the back of high growth
in IT, healthcare, retail, telecom, financial
services, entertainment, leisure & tourism
and other services sectors.
4
RAMA
TREMENDOUS POTENTIAL FOR HOUSEHOLD AIR CONDITIONER
MARKET TO GROW, GIVEN LOW PENETRATION
Very low
penetration
Leading to huge untapped potential of 83 mn*
Per cent of all
households
Taiwan
Million
70
182
67
Hong Kong
Korea
52
Malaysia
45
Thailand
24
China
20
Indonesia
India
7
1
0.1
1.7
1.8 180
64
61
Small
towns
and
Rural
33
144
144
3
28
83
+
Multiple
ownership
5
55
Urban
38
Total
HH
36
28
HH with Untapped Unelect- Below Untapped
refriger potential rified
poverty potential
ators
line
*After removing households below poverty line and in uncertified areas
5
Source: Francis Kanoi; NCAER
RAMA
HOWEVER GROWTH IS LOWER THAN POTENTIAL AS AC IS VERY
EXPENSIVE PURCHASE EVEN FOR HIGH INCOME CLASS (1/2)
Price income multiple for ACs in China**
Income
class
P/I multiple
Penetration
Per cent of
all HH
Bottom
40%
Next 20%
Next 20%
1.35
0.81
0.63
Sizable population in India finds ACs expensive
Income
class
Penetration
MHI***
Per cent
Top 10%
0.50
0.34
Up to
12,000
35
12,000 –
16,000
43
0.7
# HH mn
1.8
10.6
23.0
1.5
1.1
78.9
2.4
1.4
53
63
* After removing households below poverty line and in unelectrified areas
** Based on Urban population
*** Monthly household income
Source: Francis Kanoi; IMRB; NCAER
@ price of
Rs.21,000
21
> 16,000
Next 10%
Price/
Monthly income Untapped
potential*
multiple
6
RAMA
HOWEVER GROWTH IS LOWER THAN POTENTIAL AS AC IS VERY
EXPENSIVE PURCHASE EVEN FOR HIGH INCOME CLASS (2/2)
Growth has been lively in household air conditioner market but less than potential
Value
Volume
Rs. Crores
‘000 units
25%
9%
31%
30%
18%
17%
26%
31%
695
533
406
340
315
176
140
190
240
85
1995
1998
2000
2001
2002
1995
1998
2000
2001
2002
7
Source: Francis Kanoi, ORG-GFK
RAMA
THE HUGE DIFFERENCE IN RETAIL PRICES BETWEEN INDIAN AND
CHINESE ACs EXPLAINS THE LOW PENETRATION, DEMAND
Chinese retail prices are more than 60% lower
than Indian retail prices
Type of AC
Indian price
US$
Chinese price
US$
This explains difference
between Indian and
Chinese statistics
Domestic market
• India : 0.3 mn units
• China : 14 mn units
Penetration
• 1 Ton window
360
136
• 1.5 Ton
420
185
window
• India : 1%
• China : 20%
Exports
• 1 Ton split
555
199
• India : Insignificant
• China : 5.9 mn units
• 1.5 Ton split
635
280
GDP
• RAC’s contribution to GDP
in China is 4 times that of
India
8
RAMA
. . . AND CHINA EMERGED AS LARGEST MANUFACTURER, EXPORTER
OF RACs ON BACK OF LARGEST DOMESTIC MARKET
Historical similarities with India: Large rural population, lack of
basic infrastructure& low penetration (till 80’s)
China
14000
India
12000
• Today China is the largest
manufacturer & exporter in
the world with a CAGR of
46% in last 11 years
10000
7800
• China leading due to
– Economic reforms,
localisation of
ancillaries, dominance
of domestic brands and
entry of MNCs
6500
5800
4800
3800
2750
1520
620
115
130
200
280
350
360
405
• In the last decade the
Chinese RAC market has
grown from 6 to 23 times
the Indian RAC market,
despite Per Capita PPP
differential of only 1.7 times
470
544
615
620
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
– Lower Prices leading to
increased affordability;
single VAT of 17%.
– Export competitiveness
due to large Scale
operations for domestic
market itself
9
Source: Appliance Magazine
RAMA
THE HIGH INCIDENCE OF INDIRECT TAXES AND DUTIES
IS THE PRIMARY CAUSE FOR THE HIGH PRICE POINTS
Effect of
government
policy
Typical 1.5 ton window AC
Rs
21000
1170
46% - Rs 9,715
22000
1000
4215
54% - Rs 11,285
Duty
effect
3395
1000
1000
2105
8115
Manufa
cturing
cost
Key
assumptions
Manufa
cturing
margin
• High
import
duty 30%
for key
componen
ts
Source: McKinsey Analysis & Interview of Players
Freight,
warranty
Sales
tax,
octroi
Excise
duty
Channel
margin
Consumer Discount
price
MRP
• Weighted • 32% with
•
average
range of
12%-21%
Octroi/
entry tax
of 3%
•
40%
abatement
AC is still
perceived
as luxury
10
THE LOW ABATEMENT IS NOT IN LINE WITH THE HIGH POST
MANUFACTURING COST NOR IS THE EXCISE DUTY ON PAR
WITH OTHER WHITE GOODS
Head
MRP
Base Value
Remark
100.00
Excise Duty
19.20
Octroi/Entry or TO
Tax
1.00
Sales Tax
15.00
Primary Freight
2.00
Secondary Freight
1.00
Dealer Margin on
MRP
12.00
Warranty Pay-out
2.50
Total Post-Mfg. Cost
52.70
@32% with 40%
abatement
Weighted Average
(Range 0 - 5.5%)
Weighted Average
(Range 12 - 21%)
Avg. Freight including
Insurance
Abatement allowed
40%, gap-12.7%
RAMA
• Highest rate of ED and sales tax
amongst white goods
– ACs: 32% ED on 60% of MRP;
sales tax of 21%
– Refrigerator : 16% ED
– Driven by perception of AC as a
luxury – today, AC is a need
especially in a tropical country
like India
– Further, amendment in the CST
Act, almost all AC sales subject
to LST which is higher than
refrigerators
• Abatement of 40% not in line with
high post manufacturing costs
– Post manufacturing costs of AC
is 52.7% of MRP leaving a gap
of 12.7% (given abatement of
40%) on which no abatement
11
Source: Industry Sources
RAMA
THROUGH CONTINUED EFFORTS BY PLAYERS BACKED BY
GOVERNMENT SUPPORT SUPPORT, THE INITIAL PRICE OF AN AC
CAN BE BROUGHT DOWN DRAMATICALLY
Typical 1.5 ton window AC
Rs
21000
4600
2300
3100
Current
price
Key
assumptions
Source: McKinsey Analysis & Interview of Players
Cost reduction
effort by
players thru
design, scale
& anciliarisation
Reduce
excise duty
to 16%
Rationalise
indirect tax
and import
duty structure
11000
Final
possible
price
• Single VAT of
•
15%
Single import
duty of 10%
across value
chain
12
RAMA
REDUCING EXCISE DUTY ON ACs FROM 32% TO 16% WILL BE TAX
POSITIVE FOR THE GOVERNMENT
Price elasticity for ACs
Current tax revenue indexed to 100
Price (Rs)
16
100
30,000
11
37
26
Total loss
due to
decrease
in tax rate
at current
volume
Offset due
to increase
in demand
at reduced
price
28,000
89
116
11
26,000
24,000
22,000
X
20,000
100 150 200 250 300 350
Volume (’000 unit)
Current
tax rev.
(ST+
excise =
35%)
Net loss
due to
lowering
excise
duty to
16%
Tax
Gain due to
revenue increased
potential compliance
(interme
diate)
Reduced
costs due to
scale leading
to reduced
prices and
increased
demand at
new duty
levels
Total
revenue
potential
Price elasticity of ~3,
meaning a 30% drop in
price will result in 100%
increase in volumes
13
Source: McKinsey Analysis & Interview of Players
RAMA
FURTHER, MOVING TO SINGLE VAT AND IMPORT DUTY WILL NOT
AFFECT TAX COLLECTION ADVERSELY
Price elasticity for
manufactured goods
Change in tax revenues
Current total tax revenue indexed to 100
700
600
500
400
100+
100
Refrigerators
1.5
23
40
14
7
5
82
+
46
300
200
Color TVs
100
0
0.00
0.50
Price/Income
1.00
Current Loss
Loss
tax rev due to due to
lowering lowering
ST+
Excise - VAT to duty to
15%
10%
25%
C.Duty –
24%
Tax
revenue
after
reduction in
rates
Indirect
Tax
gain
due to
increased sales
Direct
Tax
gain
due to
increased sales
Gains in
tax
revenue
Gain
due to
increased
compliance
Gain in
duty
revenue
due to
higher
consumption
Revenue
potential
Company
driven
actions to
lower
prices,
hence
improve
demand
and tax
collections
Total
Rev.
potential
Gains in
duty
revenue
14
Source:CII-McKinsey Study on “Learning from China to Unlock India’s Manufacturing Potential”
RAMA
THE FINAL OUTCOME WILL BE A WIN-WIN-WIN SITUATION FOR
PLAYERS, GOVERNMENT AND CONSUMERS
• Domestic AC market can be a huge market by 2007
• Size of domestic market Rs 6280 crore and 4.3 million units with further
growth possible
• Increased standard of living for consumer
–
AC will become a need and productivity enhancer
• Growth in exports will earn foreign exchange for country
• Scale in domestic market will drive competitiveness in exports (e.g., Chinese
exports of 5.9 million units driven of domestic volume of 14 million units)
• Household AC exports can be Rs 700 crore
15
ON THE OTHER HAND, NOT IMPLEMENTING INITIATIVES
WILL CONTINUE TO HAMPER INDUSTRY PROFITS AND
A MAJOR OPPORTUNITY WOULD BE LOST
Price cost squeeze adversely affects players’ profitability
120
100
RAMA
Price (Index 1998
to 100)
Total variable cost
(Indexed 1998 to
100)
• Further price
reduction very
difficult at
current costs
• Current costs
difficult to reduce
at current
volumes
• Industry
deadlock
80
60
40
20
0
1998
Source: Analysis
1999
2000
2001
2002
16
PROPOSALS TO GOVERNMENT - EXCISE DUTY, 1
1
RAMA
Excise duty rates and exemptions
Excise duty rates - Air-conditioners (84.15)
• Excise duty and abatement to be brought on par with white goods (16% excise duty
and 40% abatement) effective March 2003
Excise duty exemption
• Excise duty exemption to SSI to be withdrawn as it has outlived its purpose & large
gap between the duty payable and the input duty is a potential threat for leakage in
revenue
• Locational exemptions for manufacturing in North-East and Jammu for airconditioners to be repealed as this has led to creation of finishing, packing & invoicing
hubs, adding to fragmentation of manufacturing and inability to capture scale
economics
–
This exemption destroys value for government, players and consumers and confer none of
the intended benefits to the system
–
The exemption is financially attractive due to large gap between duty payable at 32% and
all inputs at 16% with no requirement of value addition or minimum employment. In fact airconditioner is the exception and not covered in the negative list
• If existing notification can’t be repealed, amend the notification by adding
–
–
condition for value addition
criteria for investment/employment
17
RAMA
PROPOSALS TO GOVERNMENT - EXCISE DUTY, 2
2
Excise exemption for Cold Chain (84.18)
• Cold chain enjoys excise exemption under General Exemption No 66
in List 44
• However, CENVAT credit on inputs is not available
• To maintain the spirit of exemption from incidence of taxes
– cold chain may be covered under payment of excise duty at 16%
– grant refund of Terminal Excise Duty (TED) to manufacturer or ;
– grant additional subsidy, equivalent to excise duty, to user
18
RAMA
PROPOSALS TO GOVERNMENT- CUSTOMS DUTY, 1
1
Customs duty
Broadly in agreement with the recommendations of Kelkar Committee:
• 2003-04 :
–25% on finished goods and
–15% on raw material, inputs and intermediate goods
• By 2004-05 : 2 tier structure with
–20% on final goods and
–10% on raw material
• By 2006-07 : single 10% import duty across value chain
Recommend equal reduction of 10% in rate of custom duty to meet
the target rates.
19
Thank You