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Air-conditioning & Refrigeration

Industry

Pre - Budget Memorandum

2003-04

RAMA

13 December 2002, New Delhi



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± Excise exemption in certain states such as Jammu, North East to be repealed as they destroyvalue for government, players and consumers and confer none of the intended benefits to thesystem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



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



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



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.



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

+



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





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



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



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





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




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




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



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



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



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



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



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.



Thank You

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