The Indian capital goods sector has grown 2.75 times over the last decade from an output of Rs. 1.35 lakh crore in 2005 to an output of Rs. 3.7 lakh crore in 2015.2 Despite the growth over last decade, the sector remains sub-scale. At USD13 billion of value-add in 2015, the capital goods sector contributes only 0.6% to India’s GDP compared to 4.1% for China, 3.4% for Germany, and 2.8% for South Korea. In order of magnitude, the sector’s value addition in China is 35 times that in India, according to a study by McKinsey & Company.
For a $2 trillion economy, the sector is still relatively under-developed. However, India’s capital goods players are limited in growth potential due to: limited investments in R&D and technology; lack of investors to capture growth; limited [email protected] sales and marketing capabilities.
The study reveals that the sector could have been weighed down due to low investments in technology and talent. In Indian capital good sector, less than 1% of revenue is ploughed back in R&D as compared to 5-6% in Germany, said Abhishek Agrawal, Associate Partner, McKinsey & Company.
The sector has attracted an annual investment of Rs. 18,000-20,000 crore and has been stagnant at 1.4% growth.
“Capital goods is now the fourth largest import category after crude oil, electronics, and gold.The future growth trajectory of the sector could be accelerated. Based on the push under the “Make in India” campaign and the trends in key end-use sectors, there are multiple growth opportunities on the horizon in India for capital goods players,” said Dr A Didar Singh, Secretary General, FICCI.
“Despite the sector being underdeveloped, there is a silver lining. Economic reforms rolled out by the government over the years and kick-starting of capex cycle in many end-use sectors have created new opportunities,” said Agrawal.
“The following seven segments, if tapped, could result in US$30 bn (Rs 2 lac crore) annual opportunity for India’s capital goods players and global OEMs: Emission norms regulations; Investments into logistics infrastructure (railways, ports, roads); Thrust on indigenization of manufacturing in aerospace and defence; Urbanization; Meeting India’s energy, material and food demands;Tapping these opportunities could also accelerate the growth of this sector, add Rs. 40,000 – 50,000 crore to country’s GDP, allow import bill to be reduced by about US$ 20-25 billion. It could also create additional 5 lakh direct jobs and 50 lakh jobs in total,” he added.
With the government's thrust on “Make in India” campaign and the trends in key end-use sectors (power,mining, oil & gas, aerospace & defence manufacturing, etc.), there are multiple growth opportunities on the horizon in India for capital goods players. Seven core investment areas and themes that the report has identified, could help generate these opportunities:
1. Investments in environmental solutions: Both citizens and policymakers are becoming increasingly aware of the environmental impact of industry and transport. As a result, stricter norms are being imposed across sectors; more stringent norms for the emission of pollutants like sulphur oxides and nitrogen oxides from thermal power plants; and tightening of water consumption norms. This could call for a new wave of capex in providing environmental-friendly solutions.
2. Investments in logistics infrastructure: The government has stepped up spending, and increased the execution rigour for, logistics infrastructure. For example, spending on railways is expected to be upwards of USD 15 billion per annum compared to historical average spending levels of USD 5 to 6 billion. The focus of this spend will be on rolling-stock upgrade, laying of tracks, electrification, and station upgrades.
3. Thrust on indigenization of manufacturing in aerospace and defence sector: Under the new Defence Procurement Procedure unveiled in March 2016, Indian designed, developed and manufactured (IDDM) is the new highestpriority category wherein a minimum 40% of locally designed equipment is required to be procured from domestic sources. This could call for the huge indigenization of future defence programs, estimated at USD 150 billion, two-thirds of which need to be made in the next eight years.
4. Investments in urban infrastructure: Metropolitan cities with million-plus populations are India’s engines of growth.McKinsey Global Institute estimates that by 2025, India will have 69 cities with a population of more than one million each.15 As India proceeds rapidly on the road to urbanization, it will need to make huge investments to upgrade the urban infrastructure for water management, waste management, transport, power, smartcity solutions, etc.
5. Meeting India’s energy demand: The energy sector in India has seen “shifting bottlenecks” over the last several decades. On the transmission and distribution side, areas like grid upgradation and new build-out, renewable energy integration into the grid, rural electrification, and smart metering are likely to attract investments. These and related opportunities could call for an annual investment of about USD 10 billion by 2020.
6. Investments in basic materials: To realize the power generation vision (“24x7 power”) and to reduce dependence on coal imports, Coal India ismoving to achieve its target of ramping up production to 1,000 MT by 2020,21 up fromthe production level of 539 MT in 2015-16. These capacity additions, and the focus on improving the grade of coal supplies, would call for newer solutions, e.g., largescale material handling for coal, surface miners, and washery solutions.
7. Investments in food infrastructure: Food consumption in India is estimated to grow at the rate of 5% per annumin the near future, which couldmean the need for an increase in crop yields by 1.3% through 2025, 24 and consequently raising fertilizer demand fromthe current 26 million tonnes of nutrients to 27 to 29 million tonnes by 2020. High prices for imported gas may continue to inhibit the domestic manufacture of fertilizers and limit the addition of significant new greenfield capacity. Increase in the consumption of complex fertilizers (usage in India is 28% compared to 36% in China and 54% in Israel) and customized fertilizers could drive new capacity additions in small-sized plants. About 25 to 30 such plants (with a typical capex of Rs. 150 to 200 crore for each plant) could come up over the next five years.