Outlook For Top Industrial Sectors

Automobile Industry In Low Gear

The automobile industry will record a bleak performance across the key auto segments going forward, primarily weighed down by rising interest rates and fuel costs. While the cars and utility vehicles segments will recover at a faster pace with stable ownership costs, the commercial vehicles segment could see a moderation in growth in 2012-13 on account of continued lower-than-expected growth in industrial production. However, the long-term prospects for the sector remain bright. CRISIL Research expects the domestic automobile market to double in size in value terms over the next five years.

Automobile industry growth to dip to one of its lowest levels in a decade in 2011-12

The automobile industry bore the brunt of rising interest rates and fuel costs in 2011-12, which has been one of its worst years in a decade. Higher interest rates, fuel costs and vehicle prices drove up ownership costs (cost of owning a typical small car, including expenses like EMI, fuel costs, maintenance and insurance) for cars. We expect the sales for cars and utility vehicles to grow by two-four per cent in 2011-12, which will be a sharp drop from the almost 30 per cent growth recorded in the previous year. Twowheeler sales are likely to grow by 11-13 per cent over a high base, in sharp contrast to the 26 per cent growth in 2010-11.

In the commercial vehicles segment, sluggish GDP growth will drag sales growth down to 16-18 per cent in 2011-12 from over 27 per cent in the previous year. Within this segment, Light Commercial Vehicles (LCVs) will continue to grow at a robust pace of 26-29 per cent in line with the evolution of the hub and spoke model, while the growth of Medium and Heavy Commercial Vehicles (MHCVs) will moderate to eight to 10 per cent, with lower industrial production.

Commercial vehicles’ sales volumes to see the lowest growth among all segments in 2012-13

A sluggish growth in industrial production is likely to weigh down the growth in sales volumes of MHCVs in 2012-13. The growth in LCVs will moderate over the high growth seen in the last two years to about 15-17 per cent. We expect two-wheeler sales growth to remain unchanged, with a buoyant growth in scooter sales amid the slowing offtake of motorcycles in urban areas. The sales of cars and utility vehicles are likely to go up, driven by stable ownership costs (led by lower fuel prices), new model launches and a probable halt in the interest rate hikes.

Domestic automobile market size to double over the next five years

The domestic automobiles market will grow more than two-fold to Rs 5.7 trillion by 2015-16. Cars and utility vehicles’ sales volumes are likely to grow at a 14-16 per cent CAGR over the period, led by increasing affordability and competitively priced models. Lower penetration rates and rising farm and non-farm incomes in the rural areas will drive two-wheeler sales. The segment is likely to grow at a 10-12 per cent CAGR over the period. Commercial vehicles’ sales are likely to grow at a 13-15 per cent CAGR, as a better organised logistics industry and higher GDP growth would drive growth in the segment. Thus, while the industry’s growth is likely to be muted over the next two years, the long-term growth potential is bright.

Car and two-wheeler manufacturers to witness sharp decline in operating margins in 2011-12

Along with the drop in the sales volume growth across segments, the intensifying competition is restricting automakers’ ability to increase vehicle prices, even as input costs rise sharply. We, therefore, expect the operating margins of car and two-wheeler manufacturers to decline by 150-200 basis points in 2011-12. Tepid demand from transporters and slowing industrial GDP growth will reduce the operating margins of commercial vehicle manufacturers by 100-150 basis points.

Small car, two-wheeler segments to see intense competition

The competition has intensified, especially in the small cars segment, where a number of new models/variants have been launched and the number of players has increased from seven to 12 over the past two years. In the two-wheelers space too, the vying for market share is intensifying, as the players are expanding their product portfolios.

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Banking Sector Still Credit Worthy





CRISIL Research forecasts a 17 per cent growth in bank credit by March 2012. A drop in capital investment across industries and the prevailing high interest rates on account of higher infl ation has slowed down the growth momentum. An increase in the interest rate on fi xed deposits by 75-100 basis points across tenures over the past eight months will hold the deposit growth at 18 per cent in 2011-12. Banks will witness pressure on their profi tability, as the increase in the cost of funds is higher than the rise in yield of the funds deployed.

Banking credit recorded growth in 2010-11

Banking credit grew by 23 per cent in 2010-11. This was driven by a sharp growth in industry credit due to a steep hike in additional demand for domestic credit in the first half of 2010-11. The demand for domestic credit rose despite the RBI's continued tightening of the monetary policy, with telecom players investing in 3G and BWA spectrum licences and broadbased credit growth in the second half of 2010-11. Retail credit picked up in 2010-11 due to rising prices of underlying assets. Credit to categories like housing, advances against fixed deposits, vehicle loans and education also
increased in the year.

Aggregate YoY bank credit growth moderated to 16.7 per cent as on November 25, 2011 from 21.6 per cent on March 25, 2011 due to a slowdown in economic and investment growth, rising interest rates and an uncertain global environment. Infrastructure credit growth moderated to 21.7 per cent in October 2011 from 39 per cent in March 2011. Credit growth to the power sector has also declined to 30 per cent in October 2011 from 43 per cent in March 2011. Project delays and a decline in capital investments, mainly in the metals, gems and jewellery and infrastructure sectors, will weigh down industry credit growth. Also dragging bank credit growth is the lower-than-expected growth in services (currently at 17 per cent YoY, vis-à-vis 24 per cent in 2010-11). CRISIL Research expects credit growth to remain at 17 per cent by March-end 2012.

Term deposits to become more attractive with the hike in deposit rates

With a 75-100 basis points increase in deposit rates in the first half of 2011-12 and a correction in the capital markets, deposit growth has moved up to 17 per cent as on November 25, 2011 from 16 per cent on March 25, 2011. CRISIL Research believes that the deposit rates have peaked and would remain at the current levels for some time. The overall deposit growth would remain at about 18 per cent by the end of March 2012. Term deposits would remain more attractive vis-à-vis other longer maturity instruments such as postal deposits, Public Provident Fund, etc. over the next few quarters because of the high deposit rates offered.

Asset quality to deteriorate in 2011-12

The asset quality of public sector banks (PSBs) continued to deteriorate over the second quarter of 2011-12, largely driven by system-driven NPAs, slippages in the normal course of business and a rise in NPAs in restructured assets. Although the higher slippages by PSBs have partially been due to a transition from manual to system recognition of NPAs, the underlying asset quality has been undermined by a sharp increase in interest rates and the global and domestic economic slowdown.

NPA levels to increase moderately over the medium term

CRISIL Research expects the NPAs in the banking system to rise in 2011-12, as asset quality-related challenges linger. The gross NPA ratio is estimated to increase to three per cent by the end of 2011-12 from 2.3 per cent in 2010-11. Several PSBs reported higher delinquencies in the second quarter of 2011-12. In contrast, the asset quality of private banks has been under control, reflecting their superior credit origination/monitoring and better quality, as well as a diversified loan book.

Banking sector to witness pressure on profitability

The banking sector is set to witness pressure on its profitability in 2011-12. CRISIL Research expects the net spreads (net profit margins) to decline by 18 basis points in 2011-12 due to a higher increase in the cost of funds as compared to the rise in yield on the funds deployed. The net interest margins would decline by around 15 basis points during the same period. Competitive pressure and the sluggish demand for credit will limit the pricing power of banks.







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Cement Industry Set To Grow

As per CRISIL Research, the cement demand in India is set to witness a robust CAGR of around nine per cent over the next five years. The infrastructure segment is expected to be the key growth driver, and housing will continue to account for a major share.With signifi cant capacity addition expected, the cement supply is forecast to considerably outpace consumption in two years, leading to a dip in operating rates. The pan-India cement prices will increase by 10-12 per cent YoY in 2011-12, and remain almost fl at in the subsequent year. A steep increase in input costs, especially power and fuel, will compress industry margins over the near term.

Muted growth in demand for cement from April to November 2011

The demand for cement saw a healthy nine per cent CAGR over 2005-06 to 2010-11, largely led by an increased focus on infrastructure development and high demand from the housing sector and industrial projects. In 2010-11, the extended monsoons and the consequent slower pace of construction and housing activity resulted in muted demand growth of around four per cent YoY. From April-November 2011, the demand for cement grew at a subdued pace of about 4.5 per cent.

Infrastructure investments to propel cement demand

In the wake of the current weak economic environment marked by high interest rates and a subdued demand from the infrastructure and housing segments, we expect the cement demand to moderate over the next two years. While the housing sector has historically driven cement demand in India, CRISIL Research expects the infrastructure segment to be the key growth driver over the next five years. The infrastructure segment, which accounted for almost 20 per cent demand over 2006-07 to 2010-11, is likely to account for around 27 per cent over the next five years. Within this segment, increased investments in the roads sector is likely to provide the primary boost in the demand for cement.

Supply additions to outstrip cement demand

The Indian cement industry remains weighed down by the ongoing supply glut. While cement demand has recorded around nine per cent CAGR over the past five years, the installed cement capacities have witnessed an 11-12 per cent CAGR over the same period. Significant capacity additions are expected over the next five years, with the majority of these expected to come onstream in 2011-12 and 2012-13. Consequently, the operating rates are likely to decline and to bottom out in 2012-13, after which they are gradually expected to recover.

Price rise largely sustained by supply constraints, especially in the South

Despite the sluggish demand and a looming overcapacity scenario, the average pan-India retail cement prices rose sharply by around 14 per cent YoY from April to November 2011, led by a steep hike in cement prices in South India. CRISIL Research expects the average pan-India cement price to increase by 10-12 per cent YoY in 2011-12. This will mainly be driven by the sharp escalation in prices in the South on account of constraints in cement supply, largely following the production cuts by many cement players. Cement prices in South India are likely to increase by 20-22 per cent YoY in 2011-12, assuming that the existing supply constraints continue to prevail in the region.

In 2012-13, while cement prices are estimated to remain almost flat in most of the regions, those in North India are likely to increase. This is because the greater transportation distance keeps North India relatively insulated from the oversupply situation in the South and the East, which together account for almost 50 per cent of India’s total cement capacity.

Profitability to be hit due to a fall in operating rates, rise in power and fuel costs

Despite increasing input costs, the sharp increase in cement prices in 2011-12 is expected to partially mitigate the fall in profitability. The input costs for cement companies are expected to increase sharply over the next two years with the hike in coal prices by Coal India, following the adoption of its new pricing method. As power and fuel costs account for almost a third of the total cost of sales for cement players, this will impact the cement industry’s profitability negatively. In addition to the rising energy costs, the overcapacity scenario in the industry will compel players to transport cement across longer distances, which will increase the lead distance travelled. The resultant increase in freight cost will further prune profitability. Over the next two years, we expect a dip of almost 600 basis points in the operating margins of the cement industry.

Top five players account for 45-50 per cent of total cement production

There are a number of players operating in the cement industry in India. Of these, the top five companies account for more than 45 per cent of the country’s total cement production. Some of the major players in the cement industry include UltraTech Cement, ACC, Ambuja Cements, Jaiprakash Associates, Shree Cement, Madras Cements and India Cements. In terms of producer market share, UltraTech Cement is the leader in India.

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Skyscraping Growth For The Construction & Real Estate Sector

The increasing focus on the infrastructure sector in India will translate into a huge growth opportunity for the construction industry over 2011-12 to 2015-16. CRISIL Research expects investments in the infrastructure segment to more than double during this period. However, in the short term, the operating margins of players in the construction industry are likely to be under pressure following an increase in the raw material prices.

Major contribution for construction opportunity to come from infrastructure

The share of infrastructure investments in the total construction investments is expected to increase from 81 per cent between 2006-07 and 2010-11 to about 85 per cent in the period between 2011-12 and 2015-16. The growth in construction investments will be driven by investments in the infrastructure segments, such as roads and power. These are together expected to constitute close to 50 per cent of the total investments over the next five years.

Roads, power, irrigation and urban infrastructure are expected to account for close to 85 per cent of the infrastructure construction investments over the next five years. Industrial investments will be driven by expansion plans, especially in the oil & gas sector.

Roads to provide highest construction opportunity

Roads, power and urban infrastructure are likely to account for close to 60 per cent of the overall construction opportunity. The increased government focus on road development is expected to accelerate investments in roads. These investments will be driven by clarity in policy framework, such as a modification in the Model Concession Agreement and the bidding process, as well as the government's emphasis on faster awarding and execution of projects. Schemes funded by the Central Government like the National Highway Development Programme (NHDP), Pradhan Mantri Gram Sadak Yojana (PMGSY) and the state government road development programmes will support growth in road investments.

After roads, power is the second-largest contributor to the overall construction opportunity. Large capacity additions and increased private sector participation in the power sector (for generation, transmission and distribution) will contribute to growth in investments. Power investments would be largely driven by the generation segment, which in turn, will be driven by capacity additions in the private sector.

Increased spending on water supply and sanitation (WSS) will drive construction opportunity in urban infrastructure. In fact, this is expected to account for close to 70 per cent of urban infrastructure investments during this period.

Higher raw material prices to weigh down profitability in 2011-12

In the first half of 2011-12, the revenue growth of 16 per cent on a YoY basis was almost in tandem with the growth in the order books of construction companies. The operating margins of the players declined marginally owing to an increase in the prices of key raw materials. CRISIL Research forecasts a muted revenue growth of 10-15 per cent YoY in 2011-12. The operating margins are expected to decline by around 100-150 basis points following an increase in raw material prices.

Industry highly fragmented, L&T accounts for highest revenue share

The construction industry is highly fragmented, and consequently, is fairly competitive in nature. Considering the growing focus on infrastructure, a number of big players operate in this segment. Larsen & Toubro is the largest player in terms of revenue as of 2010-11.

REAL ESTATE

CRISIL Research expects residential real estate capital values across the 10 major cities – Ahmedabad, Bengaluru, Chandigarh, Chennai, Hyderabad, Kochi, Kolkata, Mumbai, National Capital Region (NCR) and Pune – to remain stable during the next six-eight months on account of subdued demand. Commercial and retail lease rentals in these cities will mirror the trend in the residential real estate space, remaining at the current levels on account of weak demand and oversupply. The sluggish residential and commercial real estate markets will continue to pressurise the cash flows of developers.

Weak residential demand to translate into stable capital values

The residential real estate demand across the 10 major cities in India has been impacted by a slowing economy, rising interest rates and high asset prices. This demand, which improved considerably in 2010 over 2009, mirroring the recovery in the Indian economy, is expected to decline marginally in 2012 over 2011. Hence, the capital values across the 10 cities are expected to remain at the current levels in the first half of 2012. Only 71 per cent of the planned supply is expected to come up between 2012 and 2014 on account of delays in execution and long gestation periods.

The capital values in Pune have crossed the peak levels reached in the first half of 2008, whereas those in most of Hyderabad’s micro-markets are considerably below the peak levels, as the uncertainty arising from the Telangana controversy has adversely affected the demand from investors and end users. Also, despite the demand from the IT/ITeS industry picking up, the capital values in all the micro-markets of Bengaluru are still below the peak levels recorded in the first half of 2008.

Commercial lease rentals across cities to remain under pressure in the near term

The commercial office space scenario in the 10 major cities remained subdued in 2011, particularly during the latter part of the year, on account of global uncertainties and the slowdown in domestic economic growth. Of the commercial office spaces planned across these cities, it is expected that less than half of these would come up between 2012 and 2014. However, even this additional supply will outpace the demand growth, resulting in huge pressure on lease rentals.

Oversupply to check mall/retail lease rentals

A supply overhang will continue in the mall/retail space across the top 10 cities. Lease rentals in the first half of 2012 will remain largely stable, with retailers remaining cautious on their expansion plans. We expect an improvement only in the second half of 2012.

In the top 10 cities, it is expected that only 124 of the 186 malls planned would come up over the next three years due to delays in execution and long gestation periods of some of the larger projects. Of the total number of malls/retail developments planned across the 10 major cities, NCR will account for 20 per cent. The current retail space across the 10 major cities is around 90 million square feet.

Consistently negative cash flows make players heavily dependent on external funding

The cash flows from operations for most companies, particularly for small and mid-sized players, have been consistently negative. Due to the consistently negative cash flows, the players rely on debt funding and financing from equity markets to tide over any cash flow crisis. None of these options are easily available in the current scenario, where the risk perception is very high. In any case, even if the finance is available, the cost of funding has increased.

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Education Sector Building Blocks For Progress

If India has to reap the benefi t of its demographic dividend, one of the most important sectors that needs special attention is education. There is no doubt that the Indian education sector has witnessed substantial growth over the past few years, and today, the country boasts of more educational institutes than any other. However, despite being home to such a large number of institutes, India’s Gross Enrolment Ratio (GER) still lags at 12.4 per cent, which is less than half the global average. While the GER in the US is 70 per cent, China’s meets the global average of 23 per cent.

The Indian government has set itself a highly aggressive target of achieving 30 per cent GER by 2020, which translates into the enrolment of 40 million students in the higher education system. We believe that achieving this challenge requires a radically new thought process and innovative solutions.

In the two decades since the economic reforms were launched, the Indian economy has attained a size of over USD 1 trillion. To sustain the growth momentum necessary to move people out of poverty, they need to be given access to opportunities. It is critical for the country to adapt itself to change and to be responsive to competitive dynamics. Its competitive edge will be determined by the ability of the people to create, apply, disseminate and secure this knowledge effectively. This transition will require India to develop its citizens into knowledge workers who are flexible, analytical,
adaptable and multi-skilled.

India’s demographic dividend that consists of a younger population as compared to developed countries is as much of an opportunity as it is a challenge. Unlike many other countries, where the young working age population is fast shrinking with higher dependency ratios, India has a demographic advantage, with about 70 per cent of the population below
the age of 35. However, this advantage can only be realised if the opportunities for education expand on a massive scale.

Recognising the critical role that education has in building skilled manpower for economic growth, the government has initiated radical reforms in the sector. The new initiatives towards reforming education have not remained limited to a specific class of students, but are broad-based in nature. The transformation in the education sector and the economic impact it could bring could be as dramatic and substantial.

According to a report published by Grant Thorton, ‘Education in India: Securing the demographic dividend’, the primary and secondary education, or Kindergarten-12th grade (K12) sector is expected to touch USD 50 billion in 2015 from USD 24.5 billion in 2008, at an estimated CAGR of 14 per cent. It is estimated that in the next 10 years, India’s education sector needs an investment worth USD 150 billion. India will need 1000 more universities and 45000 more colleges to cater to an estimated 40 million students by 2020. According to E&Y, the achievement of this target would be greatly facilitated by a three-pronged approach, as follows.

Optimising the existing capacity

Approximately 15-30 per cent of the existing capacity in the higher education sector is estimated to be underutilised. Increasing utilisation in the existing capacity would thus reduce the incremental requirement of 24 million seats. Taking a pure bottom up approach of building a new campus would thus result in over creation of capacity or underachievement of GER.

Encouraging private sector participation

The public education system in India, unlike that in many other countries, is not the preferred system for most of the population. While there are over 1.1 million government-owned schools in India, over 30 per cent of Indian students choose to study in privately-owned schools. Most of them are in schools that are entirely privately funded. The percentage of students opting for private education is on the rise, as families shun the public school system for its low quality – perceived or real – implying that those who can afford private schooling usually opt for it.

Indian households spend large amounts on education for their children, often allocating 10 to 15 per cent of their consumption expenditure for the same. On the other hand, government expenditure on education is rising, with the central government alone budgeting approximately Rs 499 billion for education in 2010-11. Including the expenditure by various states, the total public expenditure on education could be estimated at approximately Rs 1.8 trillion, or around 3.5 per cent of the GDP.

As the sector is expanding substantially, a lot of corporate houses have recognised the potential of the education industry and investing large sums of money in it. Some of the key private players who have ventured into the sector are Reliance, Educomp Solutions, Everonn Education, NIIT, Aptech, Navneet Prakashan, Camlin, Eduserve and so on.

In fact, the records also suggest that the private mechanism has been responsible for setting up of the finest educational institutions in India:

• Indian Institute of Science (IISc), Bangalore, and Tata Institute of Fundamental Research (TIFR), Mumbai, were both established by J.N. Tata.
• Shantiniketan, presently known as Viswa-Bharati University, was founded by Nobel Laureate, Rabindranath Tagore, in the early 1900s.
• Xavier Labour Relations Institute (XLRI), one of the finest management schools in India, was founded in 1949 by Fr. Quinn Enright.
• Birla Institute of Technology & Science (BITS), Pilani, was founded by noted industrialist G.D. Birla.Today, the Birla Education Trust is one of the biggest educational trusts in the private sector in India.
• Tata Institute of Social Sciences (TISS) was established in 1936 as the Sir Dorabji Tata Graduate School of Social Work.

Using new models for growth

The government should develop a PPP model, wherein government resourses and private sector best practices can be used synergistically. The state government could provide support through infrastructure and utilities at subsidised costs and by granting local approvals. Under the domestic tax law, education is a ‘charitable activity’, and provides tax exemptions on income. However, no similar incentives are provided to entities engaged in the development of infrastructure for educational purposes. The need for tax holidays for entities that invest in the creation of infrastructure for education (on the same lines as those provided in the tax law for the development of other infrastructure segments) will positively impact the creation of additional capacities. Among other initiatives, this would go long way in helping the government in achieving its targeted gross enrolment ratios.

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Fast Moving Consumer Goods In The Express Lane



Fast Moving Consumer Goods (FMCG) includes a wide range of products categorised broadly into segments viz. household care, personal care and food & beverages. The sector can be further classified into premium and popular segments. The premium segment, which makes up approximately 25 per cent, caters mostly to the higher/upper middle income consumers, while the price-sensitive popular or mass segment, which comprises the bulk of 75 per cent, consists of consumers mainly from semi-urban or rural areas.

The Indian FMCG sector, which is the fourth largest sector in the economy, creates employment for more than three million people in the downstream activities, and has a market size of more than Rs 85000 crore. Strong brand equity, wide distribution networks, low penetration levels, low operating costs, low per capita consumption and intense competition between the organised and unorganised segments are the characteristics of this sector. Brand equity is developed over a period of time through technological innovations, consistent high quality, aggressive advertisements and marketing innovations.

FMCGs in India have a strong and competitive presence with multinational corporations (MNCs) across the entire value chain. According to a study conducted by AC Nielsen, 62 of the top 100 brands are owned by MNCs and the balance are owned by Indian companies. The middle class and rural segments of the Indian population are the most promising markets for FMCGs, and provide brand makers the opportunity to convert them to branded products. Most of the product categories like jam, toothpaste, skin care products, shampoo etc., have a low per capita consumption as well as low penetration levels, but the potential for growth is huge.

The continued growth trajectory of the Indian economy, coupled with rapid urbanisation, increasing literacy levels and rising per capita income will remain key drivers for this industry.

The Indian FMCG market is estimated to grow to USD 100 billion by 2025 from USD 12 billion in 2011, according to market research firm Nielsen’s report entitled ‘Consumer 360’. The report has identified four key trends that will drive product consumption and the switch from commodities to brands, ranging from indulgence to regular consumption and acceptability.

Industry Categories and Products

Household Care
The products for personal wash and detergents fall under the household care segment. This segment is characterised by high levels of penetration and competition. The demand for household care products is growing due to urbanisation and rural demand and innovation in product offerings, for example, small sachets. However, there is huge competition from the unorganised segment, viz. local and regional players in the rural market.

Personal Care
The personal care segment comprises products catering to skin care, hair care and oral care. The penetration level of this segment is low in India. The increase in disposable incomes, changing lifestyles as well as innovative product offerings are expected to drive the growth of this segment.

Food and Beverages
This segment comprises processed food, branded staples, edible oils, ready-to-eat products, snacks and beverages, viz. soft drinks, tea, coffee, etc. The penetration level of this segment is low in India. The increase in household incomes, rapid urbanisation, changing lifestyle patterns and product innovations will drive the growth of this segment.

Government Support

Governmental Policy
In order to attain international competitiveness, the Government of India has formulated various policies, including the reduction of excise duties, facilitating automatic foreign investments, the lifting of quantitative restrictions, setting up of 100 percent export-oriented units and permitting the free use of foreign brand names.

The target for agriculture credit limit has been raised by Rs 1,00,000 crore to Rs 5,75,000 crore in 2012-13. The increase in credit was demanded by the industry and was fulfilled. The increase in credit will allow the farmers to have easy access to funds which would further increase the crop production. Further, the FM retained the interest subvention scheme for providing short-term crop loan to farmers at 7 per cent interest rate. An additional subvention of 3 per cent will be available to prompt paying farmers.

Foreign Direct Investment (FDI)

Through the automatic approval route, the government allows 100 percent foreign equity or 100 percent non-resident Indian (NRI) and Overseas Corporate Bodies (OCBs) investment across the food processing sector, except in malted foods, alcoholic beverages and small scale industries (SSIs).

Industry Performance Trends
India’s FMCG sector has registered a CAGR of around 12 per cent since 2001. This healthy performance was a result of the increase in disposable incomes, changing demographics, changes in spending patterns as well as better access and exposure to media. The growth was driven by an increase in demand in the entire product category as well as across the urban and rural markets.

The penetration levels for most FMCG categories in India were low as compared to those of other developing countries. Rising incomes, favourable demographics and Indian consumers’ aspirations to shift from un-branded products to branded ones combine to offer significant growth opportunity.

Price Trends: Raw Materials and Finished Goods

The key raw materials for the FMCG sector are either agro-based commodities or palm oil and other crude-linked inputs, all of which are highly volatile in nature. Furthermore, the inflationary pressures are likely to strain the companies’ profitability margins.

The prices of raw materials have been quite volatile over the last few years. Most part of FY12 saw a significant jump in the raw material prices. Going forward in FY13, though, the inputs are likely to witness some softness.

During FY11, despite a healthy sales growth, the profits remained almost flat. The prices of key raw materials, viz. crude and palm oil increased on a YoY basis. Furthermore, the other costs, i.e. advertising and power & fuel also increased YoY as compared to the income. The companies were able to pass on only a portion of the rise in input costs to the end customer.

Generally, with inflationary pressure on the raw material prices, large-sized companies may increase their selling prices to cover the costs. Since these companies have strong brands, they are able to pass on the price increase to the end consumers. In FY11, with a continuing increase in raw material prices, the companies did increase the selling prices. However, these prices are either not enough to compensate for their higher costs or are introduced with a time lag. Furthermore, if the companies raise their product prices, volume growth could be restricted.

Industry Outlook And Concerns

The GDP growth leads to consumers’ growing disposable incomes, which is directly linked to an increased demand for FMCGs. In addition to this, a large young population driving demand growth in the rural and semiurban regions, the continuous rise in their disposable incomes, changing life styles and the introduction of innovative offerings continue to be
the primary growth drivers for this industry.

A revenue growth of 11-12 per cent is expected in the sector till FY13, which is likely to be driven by both higher realisations and volumes. However, due to an expected rise in the key input prices, coupled with an increase in other expenses, the cost pressures are expected to continue during FY13, resulting in net margins at around seven-eight per cent.

The only threats to this strong growth trajectory remain the high portion of unorganised trade, the rising sale of fake or counterfeit products, limited distribution networks of new entrants and the pressure on profit margins due to increasing competition. These are likely to be improved with the increase in organised trade and investment in improving distribution
networks.






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Gems & Jewellery : A Jewel In The Crown



Gems and Jewellery (G&J) is one of the sectors which, in the past and till date, has been one of the main contributors towards India’s exchange earnings. The sector as a whole has accounted for 16.67 per cent of India’s total merchandise exports for 2010-11. The volume of exports is pegged at USD 43139 million as of March 2011. It is expected that the sector is likely to witness a whopping 15-20 per cent growth for 2011-12.

India presently holds the lion’s share, exporting 95 per cent of the world’s total diamonds. The country is recognised as the diamond cutting and polishing capital of the world, processing more than 90 per cent (11 out of 12) of all rough diamonds produced per year (around 80 per cent in terms of carats and around 55 per cent in terms of volume).

Globally, the G&J industry has witnessed significant changes and has exhibited growth over the past decade on account of increasing income levels as well as the demand from emerging economies. Traditionally, the US has accounted for more than 45-50 per cent of the global jewellery market. The demand was significantly affected during the financial crisis of CY2008, sending ripples across the world. In a traditional market like India though, the spending on gold and diamond jewellery is not only for their ornamental value but also as a means of safe investment.

The G&J industry is classified into five main segments: cut and polished (C&P) diamonds, gemstones, gold and diamond jewellery, pearls and synthetic stones and others – which include precious metal jewellery (other than gold), synthetic stones and costume fashion jewellery. The net export value of G&J with reference to coloured gemstones during April 2011 and January 2012 stood at USD 297.02 million, while that of C&P diamonds stood at USD 19705.41 million. These aggregate to industry exports worth USD 35499.52 million, according to the provisional Gems and Jewellery Export Promotion Council (GJEPC) data.

Industry performance

The global financial crisis of FY09 has severely affected the Indian G&J sector. The demand from the developed markets remained subdued, since consumer spending in those, countries especially in the luxury goods segment (which includes G&J), has been restrained. However, despite this global slowdown, India remained the biggest diamond processing centre and the largest gold consuming nation in the world. The record gold and silver prices is bringing a paradigm shift in consumer preference, as gold has reemerged as an alternative asset class for investment during times of global uncertainty and high domestic inflation. During the last 10 years ending FY11, the G&J exports witnessed a CAGR of 21.33 per cent.

With the demand from developed nations increasing, the growth in FY11 in USD terms increased substantially at 46 per cent on a YoY basis. C&P diamonds still lead the pack with a 65 per cent share in the export basket, followed by gold jewellery that has a share of 30 per cent. The exports of C&P diamonds increased by 81 per cent in dollar terms from USD 28251 million in FY10 to USD 15561 million in FY11. India’s biggest G&J export destination is the UAE (48 per cent), followed by Hong Kong (22 per cent) and the USA (12 per cent).

Industry outlook and concerns
With improved demand from western markets, the G&J industry is expected to continue with its positive and sustainable growth pattern going forward. Despite record gold prices in the USD 1600-1900 per ounce range, the domestic jewellery industry is now expected to undergo a shift in consumption pattern towards diamond studded jewellery and silver jewellery as fashion accessories, with minimal use of gold content. Currently, the modern retail players in the space have only five-seven per cent share of the total jewellery market, but this number is expected to increase considerably to more than 10-12 per cent in the near future. In the long term, the domestic G&J sector is poised to grow at CAGR of 10-12 per cent till FY15, based on factors such as a growing young population with higher spending on discretionary goods, higher disposable incomes, increasing organised retail and a higher proportion of working women.

Globally, the diamond miners have agreed to increase the rough diamond output after the slowdown in previous years, when the demand was impacted. The emerging markets of India, China, Russia and the Middle East (notably UAE) are expected to drive future demand, even as see a gradual reversal in fortunes and a revival in demand from the US and European markets.

G&J industry in India:

Government initiatives
India is emerging as a big consumer market for jewellery and other luxury products and thereby, presents an attractive opportunity for major brands to establish their presence. The booming domestic market along with the industry’s export advantage and the government’s decision to allow foreign direct investment (FDI) of up to 51 per cent in single brand retail stores has attracted a large number of players to the sector.

G&J industry in India:
The road ahead
Gems and Jewellery Export Promotion Council (GJEPC), which is the apex body for the G&J trade in India, Bharat Diamond Bourse (BDB), Mumbai Diamond Merchants Association (MDMA) and Diamond Exporters Association Ltd (DEAL), have felicitated four Indian diamantaires for being appointed as Counsel Generals. This ‘never-before’ can be
marked as a milestone for the G&J industry. This feat will certainly position these industry leaders as forerunners for discovering new opportunities in the international arena. Branded jewellery is the new mantra in the market, having rapidly acquired a niche over the past few years. The growing purchasing power and disposable incomes of India’s middle class have resulted in the consumption growth of this industry. Focussed marketing, creating awareness and demand for the products, building an innovative product range and category expansion, transparency and adherence to best practices will help build consumer confidence. With Indians’ fascination for gems and jewellery, the demand is expected to increase to USD 30 billion in 2015, according to industry experts. The huge growth of the Indian G&J industry has seen the advent of many new branded jewellery shops in various metro cities in the country.

Brands such as Damas Jewellery, Reliance Retail, Swarovski and Joyalukkas are in the process of opening their branches here, or have already done so. The availability of cheap labour in addition to the presence of skilled people in various states of India is helping in the growth of the diamond polishing and gold jewellery markets. According to experts in the jewellery industry, the surge in demand for expensive jewellery is a result of the strengthening of the Indian economy. Further, the emergence of use of jewellery as a fashion statement as well as for daily use and gifting has fuelled demand growth in the G&J sector.




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Big Investments In The Infrastructure Sector

If we look back at the last couple of years, it has not been such a smooth ride for the infrastructure sector. Although FY2010-11 saw the completion of the recovery process of the sector from the impact of the global financial crisis unleashed by the sub-prime crisis, it could not carry the momentum into FY2011-12. There were various factors, both domestic and international, that thwarted the momentum.

The slack in the advanced economies and the uncertainty about their future growth, employment and debt are a few international factors that still impinge upon infrastructure activity in India. In addition to this, domestic factors like indecision at the central government level, policy paralysis, an inactive bureaucracy, the worsening fiscal deficit and a higher interest rate have severely impacted the investment momentum.

However, we believe that these are the temporary blips and that the long-term growth of the infrastructure sector in India remains intact. The growth of the infrastructure sector goes in lockstep with the GDP growth of the country. If we look at the Indian economy, despite all the impediments, it is still poised to grow at the rate of seven per cent, second only to China in the major economies of the world. To sustain the drive, especially for developing countries like India, it is important to develop efficient, reliable, and affordable infrastructure services such as roads and highways, railway, ports and airports, telecom, electricity, etc.

The Government of India (GoI) has been focussing on increasing the proportion of infrastructure investment to the GDP in the current Five Year Plan. In the Union Budget 2011-12, the GoI reiterated the need to develop infrastructure in the country by assigning a significant portion of the planned allocation towards the infrastructure sector. The GoI has increased budgetary support towards critical infrastructure programmes such as Bharat Nirman, Indira Awas Yojana, Rajiv Awas Yojana, etc.

Apart from this, active participation of the private sector is also required in order to meet a large volume of resources. To encourage private sector participation, the government has announced several incentives like tax exemption, duty free import of various equipments required for development of other infrastructure, etc. According to one estimate, in the next five years, the private sector will play an important role in pumping up a large chunk of investment for infrastructure development. For example, of the total investment of Rs 9 trillion in the power sector, 57 per cent is expected to come in from the private sector. Similarly, in the road sector out of a total investment of Rs 6.9 trillion, 35 per cent will be met by the private sector. Let’s take a look at what type of investment we can expect in the infrastructure sector in the coming years.

Projected investment in infrastructure in the Twelfth Plan

The Indian economy will enter the Twelfth Five Year Plan in a much stronger position as far as infrastructure is concerned than existed at the start of the Eleventh Plan. Investment in infrastructure will be at around 8.37 per cent of the GDP in the base year of the Twelfth Plan. If the GDP in the Twelfth Plan period grows at a rate above nine per cent, it should be possible to increase the rate of investment in infrastructure to around 10.70 per cent in the terminal year of the Twelfth Plan period as indicated below (See table).

These projections imply that the investment in the infrastructure sector during the Twelfth Plan would be of the order of USD 1024.81 billion. At least 50 per cent of this should come in from the private sector. This would imply that the public sector investment in infrastructure would increase from Rs 13.11 lakh crore in the Eleventh Five Year Plan to around Rs 20.5 lakh crore in the Twelfth Plan at 2006-07 prices. It requires an annual increase of about 9.34 per cent in real terms.

There are various sectors that comprise infrastructure segment. Let’s take a look at some of the important ones.

Roads and Highways

A good road network is a critical infrastructure requirement for rapid growth. It provides connectivity to remote areas, accessibility to markets, schools and hospitals, and opens up backward regions to trade and investment. Roads also play an important role in inter-modal transport development, establishing links with airports, railway stations and ports.

India’s roads are already congested, and are getting more so. The country has the world's second largest road network, aggregating over 3.34 million km, and account for 65 per cent of freight and 80 per cent of passenger traffic, according to the National Highway Authority of India (NHAI). Going forward, the annual growth is projected at over 12 per cent for passenger traffic and over 15 per cent for cargo traffic. The government has introduced plans to increase investments in road infrastructure from around USD 15 billion per year five years ago to over USD 23 billion in 2011-12. The quantum of funds invested as part of these programmes will significantly exceed those invested in recent history.

The programmes would be funded via a mix of public and private initiatives. The GoI, via the National Highway Development Program (NHDP), is planning more than 200 projects in NHDP Phase III and V to be bid out, representing around 13000 km of roads. The average project size is expected to be around USD 150-200 million. Larger projects are likely to reach the USD 700-800 million range. About 53 projects with an aggregate length of 3000 km and an estimated cost of around USD 8 billion are already at the pre-qualification stage. The procurement process favours players with good experience and sound financial strength. And the opportunities do not stop there. More than 10 states are also actively planning the development of their highways. While the average size of these projects is smaller than those of the NHDP projects, most of them will still be substantial, in the USD 100-125 million range.

Rail

The Indian government has also recognised the existing infrastructure gaps and capacity constraints in the railway system. The Dedicated Freight Corridor (DFC) project is designed to alleviate congestion on the rail routes between Delhi-Mumbai and Delhi-Kolkata by building long-distance, cargo-only rail lines, at an estimated cost of USD 6-7 billion. Other proposed initiatives include the development of manufacturing plants for rolling stock with long-term committed procurement for several years, and the setting up of logistics parks.

City metro systems are also in the pipeline. The first corridor of the Mumbai Metro Project has been awarded to Reliance Infrastructure and the GoI has asked the final shortlisted companies to submit detailed financial bids for the second phase of the project. The Indian Railways is also looking for private partners to help modernise railway stations to world-class levels, and for projects focussed on increasing connectivity with ports.

A total investment of USD 75 billion was planned by 2012. This includes 22 stations identified for development, two dedicated freight corridors and two new locomotive factories in Bihar. Other metro projects include the Delhi Metro expansion, Bengaluru Metro and the Kolkata Metro.

Ports and Airports

Ports play an important and dynamic role in the supply chain involving complex international production and distribution. They are also important to stimulate trade and regional development. India has 7500 km of coastline, but only 12 major ports and 187 minor ports. Increasing the connectivity with inland transport networks is just one of many challenges currently facing India’s ports, which have seen massive swells in the amount of goods transported.

India’s existing ports infrastructure is not sufficient to handle the increased loads. On the other hand, the cargo unloading at many ports is currently inadequate, even where the ports have already been modernised. An investment of around USD 22 billion was targeted for port projects in the five year period from FY07-FY12. The National Maritime Development Programme (NMDP) includes 276 projects, with a required investment of about USD 15 billion over the next ten years, with private investment targeted at around USD 8 billion. The recent deregulation of the sector now permits 100 per cent FDI, and an independent tariff regulatory authority has been set up to facilitate projects at major ports.

With regard to the airways, the civil aviation traffic has seen unprecedented traffic in the past few years on account of a booming Indian economy, the growing tourism industry, the entry of low-cost carriers in the private sector and the liberalisation of international bi-lateral agreements and the civil aviation policy. In the future too, the civil aviation traffic is expected to grow at the same pace, despite the current slowdown due the factors affecting a few airline operators.

India has 16 international and 87 domestic airports. The PPP model has been successful in Bengaluru, Hyderabad, Mumbai and Delhi. The investment in airports by 2012 was estimated to be at USD 10 billion. Some projects include the upgrading of the Kolkata (East) and Chennai (South) airports. Other opportunities exist for greenfield airports in Noida (USD 365 million), Navi Mumbai (USD 610 million), Goa (USD 365 million), Kunnur (USD 365 million) and Pune (USD 365 million). The modernisation of 35 non-metro airports will involve an investment of USD 1.5 billion. In next five years, passenger traffic is expected to see a CAGR of 15 per cent and cargo traffic will grow at 20 per cent.

Even if these estimates prove somewhat optimistic, the growth already achieved has put tremendous pressure on the airport infrastructure, and private sector participation is expected to play a key role. The private sector has already stepped up to the challenge of airport infrastructure development in several cases, with private participation in recent years at Delhi, Mumbai, Hyderabad, Cochin and Bengaluru supplementing the efforts of the Airports Authority of India (AAI).

Power

While the Indian power sector has witnessed a few success stories in the last four-five years, the road ahead is dotted with innumerable challenges resulting from the gaps that exist between what has been planned versus what the power sector has been able to deliver. We have already seen slippages on the planned approximately 79 GW capacity addition.

It is evident that the deficit in power availability in India is a significant impediment to the smooth development of the economy. In this context, bridging the gap in demand and supply has become critical. Consequently, large projects are being undertaken in different segments of the sector, viz. generation, transmission and distribution. As India has not witnessed such a large scale of implementation before, there is a need to review and enhance project execution capabilities to help ensure that the targets are met.

Due to the surge in the power sector, it has witnessed higher investment flows than was envisaged. The Ministry of Power is believed to have sent its proposal for the addition of 76000 MW of power capacity in the 12th Five Year Plan to the Planning Commission. The Power Ministry has set a target for adding 76000 MW of electricity capacity in the 12th Five Year Plan (2012-17) and 93000 MW in the 13th Five Year Plan (2017-2022). During this period, an investment of about USD 122 billion is expected in power generation projects. Some of the prominent policies that have boosted the private players’ confidence in the sector are the National Electricity Policy, the Ultra Mega Power Project Policy, the Mega Power Policy, the CERC Policy and the Tariff Policy.

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Non-Banking Finance Companies Treading Cautiously

Non-banking Finance Companies (NBFCs) are financial services companies like banks that provide their services to different sectors of the economy. Unlike banks however, which provide a whole range of fi nancial services including deposits, loans for different purposes, funds transfer etc., NBFCs are focussed on particular segments. This implies that the individual NBFCs are very diverse in nature, depending upon the segment on which they focus. Some of the lending segments for these companies include commercial vehicle loans, construction equipment loans, car loans, loans against gold, property or shares, personal loans, corporate loans.

The strategy for each NBFC varies depending upon the niche that they create in product segments, or in some cases, depending on the regional focus. Strong NBFCs have well-established business models in high growth segments that are difficult to replicate by other players (including banks and other NBFCs).

While the key difference and also the main source of their business strength is that the NBFCs are focussed while banks provide generalised services, there are other important differences between the two service providers. Banks are allowed to accept demand and savings deposits, while NBFCs are not. Banks are required to take prior approval from the RBI before opening new branches, while NBFCs can open branches without RBI approval. The overall regulations for banks are more stringent than those for NBFCs – Cash Reserve Ratio (CRR) and Statutory Liquidity Requirement (SLR) are requirements that banks need to follow while NBFCs don’t; Non-performing asset (NPA) recognition norms, provisioning norms and sector exposure norms are more stringent for banks; banks have direct lending requirements; the minimum Capital Adequacy Ratio (CAR) is nine per cent for banks and 15 per cent for NBFCs. Overall, NBFCs have greater flexibility in operations as compared to banks.

On a macro basis, NBFCs supplement the role of banks and in most cases, work in partnership with them. A large proportion of NBFC funding comes from banks. A lot of loans that NBFCs extend qualify as ‘priority sector lending’, i.e. to sectors like small road transport operators, agriculture, etc. which are considered as critical sectors by the government. As banks have to extend 40 per cent of their loans to the priority sector, a part of the requirements are met through NBFCs for on-lending or buying their priority sector portfolio.

Classification

Originally, the NBFCs registered with the RBI were classified as follows: 

1. Equipment leasing company
2. Hire-purchase company
3. Loan company
4. Investment company

However, with effect from December 6, 2006, the NBFCs have been reclassified. They are now classified into four categories based on their business activity:

Asset Finance Company (AFC)

A company financing real/physical assets for productive / economic activities. At least 60 per cent of the income and assets of the NBFC should be towards asset financing for it to get classified as an AFC. AFCs have certain advantages over loan companies or investment NBFCs in terms of the regulatory requirements.

Infrastructure Finance Company (IFC)

A company that focusses on the infrastructure sector. 75 per cent of the NBFC’s assets and income should be from infrastructure-financing assets for it to get classified as an IFC. IFCs have advantages over other NBFCs in terms of raising resources and exposure norms.

Loan Company (LC)

A company that provides loans and advances but does not get classified as an asset-financing business.

Investment Company (IC)

A company set up with the primary objective of making investments.

Based on the source of funding, NBFCs are also classified as deposit accepting and non-deposit accepting. Non-deposit accepting NBFCs are further divided into being systematically important (NBFC-ND-SI) with assets more than or equal to Rs100 crore and non-systematically important with assets less than Rs 100 crore.

The total number of NBFCs registered with RBI (as on March 31, 2011) was an astounding 12626. Of these, however, there were only 312 NBFC-ND-SIs and 311 deposit accepting NBFCs.

Industry Performance Trend

The NBFC sector faced significant stress on asset quality, liquidity and funding costs during FY09 due to the global economic slowdown and its impact on the domestic economy. While all the NBFCs were affected, the impact varied according to the structural features of each NBFC. NBFCs that had higher liquidity mismatches faced more stress. Companies that focussed on unsecured asset classes also had a difficult time during the crisis. The RBI put into place measures to provide liquidity support to the sector for the first time, which highlighted the explicit acceptance of the systemic importance of the sector. This period also saw the exit of some of the foreign banks/grouppromoted NBFCs due to the revision of their global strategies.



FY10 though, was marked by the realigning of liability profiles, tightening lending norms, coupled with the closing down of many unsecured loan segments.

Total Assets

The total assets of the sector witnessed a good growth during FY11 after a difficult year in FY09 due to the global financial crisis. The total assets of NBFCs-D (deposit accepting NBFCs) increased by 27.44 per cent on a YoY basis during FY11 to touch Rs 842649 crore.



Industry Outlook

Post the financial crisis, some players have further raised equity and have managed to re-align their business models while maintaining their solvency. The sector also has better asset liability management and is more focussed on relatively safer asset classes.The crisis has imposed an overall sense of ‘caution’ even for the newer entrants in the market. Also, going forward, the higher capital adequacy norms will put a fairly conservative cap on the leverage of the sector thereby improving the credit profile of many entities.

On a structural basis, the sector is now more robust due to the lessons that the NBFCs have learned from this crisis. The profitability is expected to be more moderate than the historical levels due to conservative asset liability management (ALM), higher provisioning and the avoidance of the high yielding unsecured loan segments. However, at the same time, the profits are expected to be that much more stable and less susceptible to liquidity related pressures going forward.



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Oil & Gas (Exploring & Production) Sector High On Energy

The growing economies in the Asia Pacific and Middle East regions will drive the increase in the global demand for crude oil over the next five years. The dependence on the Oil and Petroleum Exporting Countries (OPEC) for crude oil supply is expected to remain stable during this period. The demand for natural gas in India is projected to grow at a modest pace on account of limited incremental domestic gas supplies.

As the fertilisers sector will continue to have the highest priority in future gas allocations by the government, the demand from other key sectors like power, City Gas Distribution (CGD), etc. will be affected by the constrained domestic gas supply. The weighted average gas prices are expected to rise over the next five years, driven by domestic gas price revisions and the increased use of higher-cost liquefied natural gas (LNG).

CRUDE OIL

Oil demand rebounded strongly in 2010 to 87.4 mbpd

As the global economy recovered in 2010 (following the policy efforts and financial stimulus provided by various countries), crude oil demand rebounded to the historically high level of 87.4 million barrels per day (mbpd) in 2010 from 84.7 mbpd in 2009. From 2005 to 2010, the incremental demand of 3.3 mbpd came primarily from the emerging countries like China, India and Saudi Arabia. On the other hand, the demand decreased in developed countries like the US, Japan and Germany on account of slower GDP growth rate and a focus on cleaner fuels.

Emerging economies in Asia Pacific, Middle East will drive long-term oil demand

According to the International Monetary Fund's World Economic Outlook, the world GDP is expected to grow at a CAGR of 4.6 per cent during 2010-15, as compared to a CAGR of 3.6 per cent during 2005-2010. This higher growth is expected to result in higher crude oil demand. Over the forecast period, CRISIL Research expects the global crude oil demand to grow at a CAGR of 1.2 per cent by 2015. The growth in demand will be led by emerging economies such as China and India in the Asia Pacific region, Saudi Arabia in the Middle East and Brazil in South and Central America. The increase in transportation activity and industrialisation in these countries will boost the demand for crude oil.

Crude oil prices to decline led by increasing spare capacity and slowing demand growth

The political unrest in the MENA (Middle East and North Africa) region pushed up crude oil prices to USD 111 per barrel in 2011. Turmoil in Libya, which accounts for around two per cent of the global production, brought the country's crude oil output to a near standstill. This resulted in the substitution of supply by other OPEC countries. This led to a decline in the OPEC spare capacity, which is estimated to have dropped to 3.4 mbpd in 2011 from 5.4 mbpd in 2010, thereby exerting upward pressure on crude oil prices. Normally, lower OPEC spare capacity results in strengthening of prices.

Going forward, the global dependence on OPEC crude oil is expected to remain stable between 2011 and 2015. This is due to the incremental supply from new fields in non-OPEC countries to counter the structural decline in their existing matured fields. However, crude oil prices are expected to decline from 2012 onwards on account of an increase in spare capacity, following the resumption in crude oil production from Libya and higher production from non-OPEC countries and Iraq. This, coupled with slower demand growth, will create pressure on crude oil prices.

GAS

Limited domestic gas supply to constrain demand growth

CRISIL Research forecasts that gas consumption in India would increase at a much slower pace over the next five years as compared to a growth of 13.9 per cent over the last five years. This is on account of limited incremental domestic gas supply and higher usage of the more expensive LNG.

The share of domestic sources in overall supplies is expected to decline over the next five years. The fertilisers and power sectors will continue to be major consumers of natural gas. However, on account of the highest priority being accorded to the fertilisers sector for future gas allocations will constrain domestic gas supply to the power and CGD sectors. This will force the latter to opt for LNG, which is more expensive, thereby slowing down demand growth from these sectors. The demand from CGD would be hit further by the delay in clearances and rollout, and the lack of regulatory thrust across all cities.

Incremental supply from domestic sources constrained in the near term, share of LNG to go up

CRISIL Research forecasts natural gas supply to witness a 7.8 per cent CAGR between 2010-11 and 2015-16. However, the supply from domestic sources is likely to remain constrained over the medium term due to a decline in supply from Reliance Industries’ (RIL) KG-D6 gas fields. LNG supplies are expected to rise during the period, driven by the fall in domestic gas output in 2011-12 and 2012-13.

Weighted average gas prices to go up driven by domestic price revisions, increased use of LNG

CRISIL Research expects the weighted average gas prices of natural gas to rise by over 40 per cent by 2015-16 from the current levels, primarily led by the expected revision in the prices of Administered Price Mechanism (APM) and RIL gas resulting from rising exploration and production costs. Further, the increased usage of LNG, which is more expensive, will also contribute to the increase in prices over the next five years.

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Power Sector Continues Load Shedding

An increase in the pace of power generation capacity additions is expected to translate into the base load deficit declining over the short-to-medium term. However, power generation companies will continue to face issues related with coal availability. Also affecting the sector is the weak financial health of the state distribution companies, which results in higher receivables for power generators and weak merchant power prices.

Domestic coal availability to restrict PLFs of power generation companies

Domestic coal availability remains constrained due to the slow progress on mining projects. Coal India, which accounts for about 80 per cent of the supply, was not able to achieve its 2010-11 production target. This was mainly because the Environment Ministry did not permit the expansion of projects falling in areas categorised as critically polluted under the Comprehensive Environment Pollution Index (CEPI). Captive coal production too is expected to post little growth due to poor progress on the allocated mines. Consequently, we expect the nationwide annual average plant load factors (PLFs) of thermal power plants to decline in the short-to-medium term.

The decline in PLFs will be more severe for plants that are based on coal sourced from Coal India and which have not secured fuel supply agreements (FSAs). Upcoming projects face a substantially higher fuel supply risk as compared to those commissioned before March 2009, which do not have enforceable FSAs with Coal India. We expect several such projects to operate at only 55-65 per cent PLFs in the initial years.

Imported coal may not be a viable option due to rising imported coal costs. Generation utilities will be unable to adequately pass on coal price increases, as most power purchase agreements (PPAs) do not provide full pass-through of fuel costs. Further, there is a pressure on merchant prices.

Weak finances of state distribution companies affect offtake, policy intervention to help power purchase

State distribution utilities account for over 90 per cent of the distribution network. With the accumulated losses of these utilities crossing Rs 1 trillion, their ability to purchase adequate power for distribution has been severely restricted. However, there are expectations of policy intervention in the form of tariff revisions and/or conversion of state loans into equity. This would improve the financial health of state distribution companies, and consequently, the offtake.

Power demand to rise steadily, base load deficit to decline sharply

CRISIL Research expects the domestic power demand to grow at a steady rate from 2010-11 to 2015-16, following a gradual improvement in power offtake by state distribution utilities. The growth in demand is not expected to be uniform across regions – the demand in the South is expected to be higher than that in the East.

While the overall demand is slated to grow at a healthy pace, capacities are projected to increase at a higher rate over the next five years. Consequently, the base load deficit is expected to decline to half. The peak load deficit, though, will fall at a more moderate pace. The peak deficit is likely to decline by a lower extent as compared to the base deficit, as gas and hydel capacities, which are the primary sources used to meet the incremental peak demand, comprise less than 20 per cent of the upcoming capacities in the forecast period.

Investments in generation to increase nearly two-fold, private players to account for largest share

Additions to power generation capacity (based on conventional energy) are expected to be nearly double the capacities added over the previous five years. However, this is still much lower than the announced capacities. Private sector participation is expected to increase significantly and comprise about 57 per cent of the total investments. Coal-based capacities will account for most of the total capacity additions. We expect gas-based capacity additions to be low on account of the limited availability of domestic gas, while capacity additions of hydel projects will be constrained by their long gestation periods.

Transmission investments to gain momentum, distribution to lag

Investments in transmission are expected to gain momentum mainly on account of the Power Grid Corporation (PGCIL) substantially augmenting the inter-state transmission system with high voltage transmission corridors for the offtake of power from upcoming generation capacities. PGCIL, which has close to 50 per cent share of the country's transmission network, has plans of investing around Rs 1 trillion over the Twelfth Five-Year Plan period.

In contrast to the transmission segment, the investment outlook for the distribution segment is expected to be subdued due to the weak financial position of the state distribution utilities. Consequently, its share in the total investments is expected to decline over the short-to-medium term.

Profitability of power generators to be under pressure

The profitability of power generation companies is expected to be affected because of fuel supply constraints. New power plants are expected to operate at low PLFs, as coal availability is constrained. Also, while plants can import coal to meet the deficit, since adequate pass-through is not a part of most power purchase agreements (PPAs), blending is unviable. The majority of PPAs provide minimal pass-through of fuel costs, constraining the ability of the power generation utility to generate high cost imported coal-based power.

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Success Sealed For The Packaging Sector

The Indian packaging industry is worth approximately Rs 84600 crore (USD 18.8 billion), and is growing at around 13 to 15 per cent YoY. The growth rate of the domestic packaging industry is more than that of the world, which is at around six-eight per cent. Packaging, as distinct from mere ‘packing’, plays its most visible and catalytic role in a modern economy, with the widespread adoption of product branding and the development of consumer preferences. Packaging helps sell products by providing product differentiation and presentation, greater brand awareness and convenience.

In India, 80 per cent of the packaging remains rigid packaging, which is the oldest form of packaging, and the remaining 20 per cent is constituted by flexible packaging. Rigid packaging includes glass bottles, metal cans, aerosol cans, battery cell cans and injection-moulded plastic containers. Plastic, which is the most commonly used substrate in flexible packaging, is surrounded by issues related with environmental protection and safe disposal. These issues act as a major hurdle for flexible packaging becoming an all-encompassing medium. Moreover, flexible packaging mandates additional capital requirements and technical know-how for efficient manufacturing operations.

The global packaging industry is worth USD 550 billion, and is expected to grow to USD 740 billion by FY2014. The size of the flexible packaging industry in India is approximately Rs 15000 crore (USD 3.5 billion), and is shared by packaging films like Biaxially-oriented Polypropylene (BOPP), High-density Polyethylene (HDPE), Low-density Polyethylene (LDPE), Biaxially-oriented Polyethylene Terephthalate (BOPET), Polyvinyl Chloride (PVC), etc. Flexible packaging is the fastest growing segments of the packaging industry, which is expected to grow at the rate of around 25-30 per cent in countries like India and China and at around six per cent in developed markets like the USA.

Industry Performance Trend

The consumer market dominates the global packaging industry. It accounts for an estimated 70 per cent of sales, with industrial application taking the remaining 30 per cent. Food and pharmaceuticals packaging are the key driving segments. India’s per capita consumption of packaging is less than USD 15, against the global average of USD 100. The large and growing middle class and the low penetration of the organised retail sector are the catalysts to growth in this sector.

Due to lower manufacturing costs, India is becoming a preferred hub for the production of packaging. It has been witnessed that all the major players are expanding their existing capacities to tap the fast-growing export market for Indian packaging products. Flexible packaging has gained vast acceptability because of the protection it offers to the product against environmental threats like moisture, heat and chemical reactions.

India’s imports at 20-25 per cent, with a value of around USD 125 million of its total packing machinery, indicate further opportunities not only for the Indian companies to increase their share in the domestic market but also for international companies to explore new business opportunities in India. The BOPET and BOPP segment is growing at a higher rate than the industry average. The domestic BOPET and BOPP industry is expected to grow at more than 15 per cent per annum. It is expected that world demand for BOPET films will continue to grow at an average of 8.6 per cent per annum to reach 3.7 million tonnes by FY2014. The growth in the Asian demand is expected to account for almost 80 per cent of the world growth over the next five years. The growth in the packaging industry in India is also attributed to the increase in the number of joint ventures and partnerships with foreign companies for better technology.

Industry Outlook And Concerns

Growth drivers like urbanisation, an increase in health awareness, export growth and the growth in organised retail will be the key areas of growth for the packaging industry. The global flexible packaging film demand is expected to grow at five-seven per cent, higher than the rigid plastic-based packaging, which is expected to grow at approximately three per cent annually.

The packaging industry is very dynamic and has undergone significant changes as the environment in which it operates is also changing, for eg. changes in laws and regulations, the introduction of new products, the globalisation of technologies and a general increase in competitiveness. There are also significant concerns around health and reliability issues such as a greater commercial pressure for freshness in packaged foods. In the drugs (pharma) sector, there is also the pressure to inform the consumer about greater details of the drug, its effects and side effects. The expansion of flexible packaging has accelerated due to a growing middle class of over 400 million, globalisation and the influx of multinationals and modern plants and equipment available to the flexible packaging industry.

The capacity additions in the industry may affect the operating margins adversely, as they are far in excess as compared to the increase in demand and the ability of the companies to completely pass on the unpredictable increase in raw materials costs due to competitive compulsions. The exposure to foreign exchange risks on account of the import of raw materials, exports and foreign currency loans may also affect the margins in the near future.

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Tough Times For The Steel Sector




The demand for steel in India is expected to grow at a slower pace over 2010-11 and 2015-16 vis-à-vis the previous corresponding period, on account of a slowdown in demand from key end-user sectors. Compounding the steel
industry’s woes in 2011-12 is an escalation in raw material prices, especially those of iron ore and thermal coal, which will compress producer margins for the year.

Steel demand has grown at a healthy pace over the last five years

The domestic steel demand saw a robust 9.7 per cent CAGR during 2005-06 to 2010-11, driven by rising investments in infrastructure and construction and a strong growth in the capital goods and automobiles sectors. In 2010-11, the steel demand increased by 10.8 per cent YoY. Among the end-user sectors, infrastructure and industrial construction together accounted for about a third of the total steel consumption during the year, followed by automobiles (12 per cent) and pipes and tubes (10 per cent).

Demand growth to go down over next two years, increase thereafter

The rising cost of finance and execution delays owing to environment clearances have led to several construction and infrastructure projects being shelved or delayed, translating into lower demand for steel. CRISIL Research estimates domestic steel demand growth to slow down to five-seven per cent CAGR over the next two years. However, from 2013-14 onwards, steel demand is expected to pick up, following an expected rise in demand from key end-user sectors like construction, infrastructure and automobiles. Growth in demand, though, will be lower than that in the previous five years.

Capacity to bunch-up in 2013-14 and 2015-16, steel players to increase export focus

Domestic steel manufacturers are expected to expand their capacities between 2011-12 and 2015-16, with large and organised players making for an 85-90 per cent share in the incremental capacity additions. A majority of the planned capacities are slated to be commissioned in 2013- 14 and 2015-16.

With supply outstripping demand, the demand-supply gap is expected to widen further, especially from 2013-14 onwards. This will force steel manufacturers to focus on exports to improve their operating rates. Large domestic manufacturers are competitive on cost as compared to global steel manufacturers, given their access to low-cost iron ore through backward integration or contractual agreements.

Steel prices to decline in 2012

Owing to higher raw material costs and a healthy demand for steel, global steel prices increased to USD 695 per tonne in 2011. However, they are expected to decline and range between USD 600-640 per tonne in 2012, on account of a moderation in demand and lower input costs. Domestic steel prices, which track the landed cost of imports, are likely to witness a similar decline.

Profitability of steel makers will decline in 2011-12

In 2011-12, international iron ore contract prices are expected to increase by 15 per cent YoY to USD 140- 150 per tonne. Domestic iron ore prices are expected to mirror the rise in international prices, as miners fix prices based on export parity. The contract prices of coking coal are also projected to rise by 30 per cent YoY to USD 280-290 per tonne. Domestic steel players are expected to pass on the increase in input costs only partially to end-use industries on account of a moderation in demand. Thus, their profitability will be adversely impacted due to a much steeper rise in raw material prices. CRISIL Research expects the profitability of large integrated players with captive access to mines to decline by 100-200 basis points to 22-24 per cent, while that of large integrated players without captive access to mines is expected to decline by 150-250 basis points to 17-19 per cent.

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Textiles Sector All Knotted Up

Garment manufacturers are likely to see a decline in profitability in 2011-12. The volumes in the domestic market have been hit on account of a rise in apparel prices, led by the imposition of excise duty on branded garments in February 2011 and a rise in input costs. The export market has seen a slowdown on account of the sluggishness in the US and EU markets. Spinning companies are also likely to witness a sharp drop in their profitability, as they have procured cotton at high prices and are unable to pass on the increase fully due to weak demand.

Readymade Garments

Demand to decline sharply in 2011-12, revive in 2012-13

A significant drop is expected in the readymade garments (RMG) sales volumes in the domestic and export markets in 2011-12, as high prices and a slowdown in economic growth affects consumer sentiments. We expect a gradual revival in demand in 2012-13, with the correction in raw material prices. The domestic demand is expected to increase by five per cent during the year vis-à-vis an estimated one per cent growth in 2011-12. RMG exports are expected to show moderate growth during the year as against a decline of 4.5 per cent in 2011-12, on account of a slight revival in demand in the US and Europe.

Profitability of domestic manufacturers to remain under pressure in 2011-12, exporters to maintain margins

During the first half of 2011-12, the operating margins of domestic garment manufacturers declined by around 60 basis points YoY. Manufacturers were able to pass on the increase in raw material costs and excise duties only partially due to sluggish demand and high competition. Exporters, though, managed to maintain their operating margins in the first half of the year, as they could increase their realisations, with most other exporting countries raising prices.

Due to the continued sluggishness in demand, the operating margins of domestic garment manufacturers will remain under pressure. The margins for the entire year would decline by 100-150 basis points in 2011-12. Exporters, though, will continue to maintain their margins at the levels recorded in the first half of the year despite the slowing demand and lower raw material prices. This is on account of the sharp depreciation in the rupee between August and December 2011. In 2012-13, the profitability of both domestic and export RMG players is expected to improve.

Cotton Yarn

Demand to decline in 2011-12, revive gradually in 2012-13

After registering a strong growth of 12 per cent in 2010-11, the overall demand for cotton yarn is expected to decline in 2011-12. While domestic demand is expected to show moderate growth, exports are estimated to decline during the year. The sluggishness in exports is due to a slowdown in the global economy.

The demand is expected to recover gradually in 2012-13 on the back of a recovery in global demand and an improvement in consumer sentiment.

Profitability to remain under severe pressure in 2011-12

From an all-time high level reached in March 2011, cotton prices plummeted in August 2011 due to a slowdown in demand in the domestic as well as the export markets. Expectations of a further increase in cotton production in Cotton Season (CS) 2011-12 also weighed on the prices.

As spinning companies had already procured cotton at high prices in CS 2010-11, most of these companies are carrying high-cost inventory. They are unable to pass on the costs due to weak demand, thus experiencing a severe strain on their profitability.

CRISIL Research expects the domestic cotton prices to decline by around 25 per cent YoY in CS 2011-12. Hence, the cotton yarn manufacturers’ profitability is expected to improve in 2012-13 on account of lower cotton prices and improvement in demand.

Market highly fragmented

The top five players account for less than five per cent of the total installed spinning capacity. The market share of these top five players is expected to fall further on account of the growing fragmentation of the industry. This is because, in the past, spinning capacities were largely attached to composite mills, while over the last decade several standalone spinning units have come up due to easy access to capital, especially under the Technology Upgradation Fund Scheme (TUFS).