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Air-conditioning & Refrigeration
Industry
Pre - Budget Memorandum
2003-04
RAMA
13 December 2002, New Delhi
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RAMA
1
SUMMARY OF KEY MESSAGES- AIR-CONDITIONERS, 1
� The Indian AC market size is Rs 2,790 crore comprising the household and commercialsegments. The market is currently at a nascent stage and shows tremendous promise togrow. However, despite the reasonable growth in the last few years, the growth potential hasnot been entirely captured.
� The key bottleneck to growth is the low affordability of ACs. This is clearly evidenced in theChinese 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. Theprimary cause for the high prices is the high incidence of indirect taxes, excise duties andimport 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 rapidlyover 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 andconsumers.
� The specific short term proposals include:
± A reduction in excise duty from 32% to 16% with 40% abatement beginning March µ03
± Excise exemption in certain states such as Jammu, North East to be repealed as they destroyvalue for government, players and consumers and confer none of the intended benefits to thesystem
± A reduction of import duty to 25% for finished goods and 15% for components beginning Mar-03
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RAMA
2
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 notavailable
� To maintain the spirit of exemption from incidence of taxes, replace exemption
to cold chain by refund/ subsidy
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RAMA
3
THE INDIAN AIR-CONDITIONING INDUSTRY IS A
Rs 2,790 CRORE MARKET
Source: Francis Kanoi; Industry estimates
Segment Value Volume Applications
1 Window ACs Rs 1200
crore
540k nos Homes, SOHO
2 Mini Split ACs Rs 730
crore
220k nos Homes, offices,
shops, showrooms
3 Ducted Splitand
Packaged AC
Rs 400crore
216k tons Commercialestablishments
4 Chillers and
Central Plant
Rs 460
crore
272k tons Industrial,
institutional and
large commercial
Rs 2,790
crore
Major players
� Amtrex Hitachi
� Blue Star
� Carrier Aircon� Daikan Shriram
� LG
� Samsung
� Voltas
� Whirlpool
� O¶General
� Matsushita
Industry investment in line with potential resulting in surplus
capacity leading to oversupply and price wars
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RAMA
4
THE RESIDENTIAL SEGMENT IS FAST OVERTAKING THE
COMMERCIAL SEGMENT IN RAC WHILE THE PACKAGED AC HAS
WITNESSED LIVELY GROWTH IN RECENT PAST
Source: Francis Kanoi; Industry estimates
Increasing share of domestic segment in RAC
� 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
Packaged AC displays, thrice the
growth of GDP
µ000 Tons
0
0
0
0
0
0
0
0
80
0
' ' ' ' ' '8
' 8 '00
'000
'00
'00
'00
'00
'00
Estimates
Actual
Commercial
Residential
215
185
165
141
123110
'97-98 '98-99 '99-00 '00-01 '01-02 '02-03
14%
� 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.
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RAMA
5
TREMENDOUS POTENTIAL FOR HOUSEHOLD AIR CONDITIONER
MARKET TO GROW, GIVEN LOW PENETRATIONVery low
penetrationLeading to huge untapped potential of 83 mn*
Per cent of all
households
Million
Taiwan
Hong Kong
Korea
Malaysia
Thailand
China
Indonesia
India
38
8 .
.
8
3 883
Total
HH
HH with
refriger
ators
Untapped
potential
Unelect-
rified
Below
poverty
line
Untapped
potential
Small
towns
and
Rural
Urban
.8
3
33
8
Multipleownership
Source: Francis Kanoi; NCAER
*After removing households below poverty line and in uncertified areas
+
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RAMA
6
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% .
0.
0.
0. 0
0. 4
Next 20%
Next 20%
Next 0%
Top 0%
Sizable population in India finds ACs expensive
Income
class Penetration
Price/
Monthly income
multiple
Untapped
potential*
Up to
2,000
2,000 ±
,000
> ,000
@ price of
Rs.2 ,000
# HH mn
0.
0.
2 .0
Per cent
.
.
.
.
2.4
.4
* After removing households below poverty line and in unelectrified areas** Based on Urban population
*** Monthly household income
Source: Francis Kanoi; IMRB; NCAER
MHI***
2
4
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RAMA
8
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 Chinese price
US$ US$
� 1 Ton window 360 136
� 1.5 Ton
window
420 185
� 1 Ton split 555 199
� 1.5 Ton split 635 280
This explains differencebetween Indian and
Chinese statistics
Domestic market
� India : 0.3 mn units
� China : 14 mn units
Penetration
� India : 1%
� China : 20%
GDP
� RAC¶s contribution to GDPin China is 4 times that of India
Exports
� India : Insignificant� China : 5.9 mn units
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RAMA
9
. . . AND CHINA EMERGED AS LARGEST MANUFACTURER, EXPORTER
OF RACs ON BACK OF LARGEST DOMESTIC MARKET
Source: Appliance Magazine
Historical similarities with India: Large rural population, lack of
basic infrastructure& low penetration (till 80¶s)
99 99 99 99 99 99 99 99 999
China
India
� In the last decade theChinese RAC market hasgrown from to timesthe Indian RAC market,despite Per Capita PPPdifferential of only . times
� Today China is the largest
manufacturer & exporter in
the world with a CAGR of
% in last years
� China leading due to ± Economic reforms,
localisation of ancillaries, dominanceof domestic brands andentry of MNCs
± Lower Prices leading toincreased affordability;single VAT of %.
± Export competitivenessdue to large Scaleoperations for domesticmarket itself
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RAMA
10
THE HIGH INCIDENCE OF INDIRECT TAXES AND
DUTIES IS THE PRIMARY CAUSE FOR THE HIGH PRICE
POINTS Effect of government
policyTypical 1.5 ton window AC
Rs
Key
assumptions
Manufa
cturing
cost
Manufa
cturing
margin
Freight,
warranty
Sales
tax,
octroi
Excise
duty
Channel
margin
Consumer
price
Discount MRP
8115
21051000 1000
3395
4215
1170
220001000
21000
� High
import
duty 30%
for key
componen
ts
� Weighted
average
range of
12%-21%
� Octroi/
entry tax
of 3%
� 32% with
40%
abatement
� AC is still
perceived
as luxury
Dutyeffect
Source: McKinsey Analysis & Interview of Players
46% - Rs 9,715
54% - Rs 11,285
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RAMA
12
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 ACRs
Key
assumptions
Current
price
Cost reduction
effort by
players thrudesign, scale
& anciliarisa-
tion
Reduce
excise duty
to 16%
Rationalise
indirect tax
and importduty structure
Final
possible
price
� Single VAT of
15%
� Single import
duty of 10%
across valuechain
21000
4600
2300
3100 11000
Source: McKinsey Analysis & Interview of Players
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RAMA
13
REDUCING EXCISE DUTY ON ACs FROM 32% TO 16% WILL BE TAX
POSITIVE FOR THE GOVERNMENT
37 26
1116
11
116
89100
Current
tax rev.(ST+
excise =35%)
Total loss
due todecrease
in tax rate
at current
volume
Offset due
to increasein demand
at reduced
price
Net loss
due tolowering
excise
duty to
16%
Tax
revenuepotential
(interme
diate)
Gain due to
increasedcompliance
Reduced
costs due toscale leading
to reduced
prices and
increased
demand at
new duty
levels
Total
revenuepotential
Current tax revenue indexed to 100
20,000
22,000
24,000
26,000
28,000
30,000
100 15
0 200 25
0 300 35
0
Price elasticity for ACs
X
Price (Rs)
Volume (¶000 unit)
Price elasticity of ~3,
meaning a 30% drop in
price will result in 100%
increase in volumes
Source: McKinsey Analysis & Interview of Players
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RAMA
14
FURTHER, MOVING TO SINGLE VAT AND IMPORT DUTY WILL NOT
AFFECT TAX COLLECTION ADVERSELY
Change in tax revenues
Current total tax revenue indexed to 100
01
100
1
100
Current
tax rev
ST
Excise -
%
C Duty ±%
Loss
due tolowering
VAT to1 %
Loss
due tolowering
duty to10%
Tax
revenueafter
reduct-ion in
rates
Indirect
Taxgain
due toincreas-
ed sales
Direct
Taxgain
due toincreas-
ed sales
Gain
due toincreas-
edcompl-
iance
Gain in
dutyrevenue
due tohigher
consum-ption
Total
Rev
poten-
tial
Company
drivenactions to
lower prices,
henceimprove
demand
and taxcollections
Reve-
nuepoten-
tial
Gains in
tax
revenue
Gains in
duty
revenue
Source:CII-McKinsey Study on ³Learning from China to Unlock India¶s Manufacturing Potential´
0
100
00
00
00
00
00
00
0 00 0 0 1 00
Price elasticity for
manufactured goods
Price/Income
Refrigerators
Color TVs
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RAMA
15
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
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RAMA
16
ON THE OTHER HAND, NOT IMPLEMENTING INITIATIVES
WILL CONTINUE TO HAMPER INDUSTRY PROFITS AND
A MAJOR OPPORTUNITY WOULD BE LOST
0
20
40
60
80
100
120
1998 1999 2000 2001 2002
Price (Index 1998
to 100)
Total variable cost
(Indexed 1998 to100)
� Further price
reduction verydifficult at
current costs
� Current costs
difficult to reduce
at current
volumes
� Industrydeadlock
Price cost squeeze adversely affects players¶ profitability
Source: Analysis
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RAMA
17
PROPOSALS TO GOVERNMENT - EXCISE DUTY, 1
1 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 air-conditioners to be repealed as this has led to creation of finishing, packing & invoicinghubs, adding to fragmentation of manufacturing and inability to capture scaleeconomics
± 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 air-
conditioner 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
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RAMA
18
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
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RAMA
19
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.
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