Since September 2001, the automobile sector has been clocking impressive growth rates, in terms of number of units sold.

While huge pent-up demand, lower interest rates, replacement cycle and improved economic performance have led to this performance, in the next three years, the challenges are immense i.e. increased competition, fragmentation, new regulations and more importantly, significant capital expenditure commitments.

Budget Measures Second hand motorcars and motorcycles would now attract a customs duty of 100% as compared to 105% earlier. New cars will, however, continue to attract 60% duty. Tractors of engine capacity more than 1800 cc for semi trailers will now attract excise duty @ 16%. The new income tax brackets, the change in exemption and deductions available to individuals and the increase in exemption for women. No change in excise duty on passenger cars and UVs. Peak customs duty reduced from 20% to 15%. Excise duty is being reduced on tyres, tubes and flaps from 24% to 16%. Customs duty on lead cut to 5%.  Budget Impact We believe that the Finance Minister's move on the direct tax aspects will result in higher disposable income, which in turn could boost auto sales. The industry's demand for further lowering of excise duty on passenger cars has not materialised. On the input side, the lowering of excise duty will lessen the costs of key raw materials, which are mostly pass through in nature. The fall in excise duty on lead will result in Exide [Get Quote] lowering battery prices, which then will be passed on to auto majors.  Sector Outlook As far as the auto sector is concerned, we expect demand for two-wheelers to grow at a CAGR of 10% to 12% in the next three years. At the same time, passenger car and commercial vehicle sales are likely to grow at a slower rate in FY06 as compared to the last three years. This is on the backdrop of higher fuel costs, increase in finance charges and the likelihood of prices increasing in the near-term in an effort to comply with the new emission norms. If an investor wishes to invest in auto stocks, it is better to go for those companies that have diversified segment and market presence (not just leveraged on India) to lower their risks.  Industry Wish List Society of Indian Automobile Manufacturers' (SIAM) key pre-budget memorandum for 2005-06 is as follows: For passenger car segment reduction in excise duty should be across the board (24% to 16%). There should a single rate of Excise Duty to replace Multiple Taxes. Duty on raw materials currently is more than the final products and therefore requires rationalisation. Infrastructure Roads and transport connectivity, Inadequate and inefficient port infrastructure, Unreliable power supply, etc have been a major impediment to growth, and have greatly escalated costs. There is a need to invest in infrastructure development and we appreciate the initiatives taken by the government to improve the roads.  Budget over the years Budget 2002-03 Budget 2003-04 Budget 2004-05 Peak customs duty reduced to 30% from 35%. Dereservation of 50 items of select components that fall under the SSI sector. Administered interest rates lowered by 50 basis points. Special excise duty on passenger car sales, MUVs and tyres retained. Petrol and diesel prices reduced. Excise Duty on passenger cars and UVs reduced from 32% to 24%. Peak customs duty reduced from 30% to 25%. Extension of R&D benefits. Significant thrust on infrastructure development, especially roads. Concerted measures to boost the manufacturing sector. Deduction of 150% allowed on in house R&D expenditure. Excise duties on tractors to be fully exempt. Target of doubling the agricultural credit in three years. Consortium of banks formed to ensure speedy conclusion of loan agreements and implementation of infrastructure projects. Duty on non-alloy steel to be reduced from 15% to 10%. Duty on alloy steel and base metals to be also reduced from 20% to 15%. Levy of 2% additional surcharge on corporate tax. [Read more on Budget 2004-05]
Key Positives Middle class story:  Increasing affluence of the Indian middle class and introduction of better quality cars has led to strong growth in the industry in terms of both market size and production capacities. Exports buoyancy:  On account of its low cost technical manpower and ever increasing focus on quality, the auto industry has emerged as an export hub, especially for the compact car segment. Exports of passenger cars from the country have increased at a healthy CAGR of nearly 38% during the past five years and increasingly more and more auto majors are lining up to set up their production bases in the country. Infrastructure thrust:  Improvement in road infrastructure has led to increased movement of goods through roadways. Close to 65% of all the goods movement in the country takes place by roads as opposed to 55% a decade ago. Also, owing to the fact that an estimated 39% of CVs plying on the roads are 10 years old, demand for HCVs is expected to grow by a robust rate in the long term. Low interest rate regime:  Close to 80% of the new cars being purchased in the country are financed, thus underlying the importance of a low interest rate regime to the fortunes of the industry. Given that interest rates are unlikely to rise at a rapid rate in the future, we expect the buoyancy in auto sales to continue over the medium to long term. Environment led benefits:  Any implementation of pollution norms in metros, whereby vehicles beyond certain age need to be phased out could further translate into higher volume growth for all vehicles, courtesy the replacement demand.		Key Negatives Concerning income growth:  The per capita income in the country has been growing at a slow rate. Since the auto industry growth has a strong correlation with the same, the momentum has to continue to ensure robust automobiles demand. Reforms need to be accelerated. Competition from imports:  With India coming under the WTO purview, competition is expected to rise multifold. Indian companies also have to contend with imports in the future. Already a number of companies are introducing vehicles in the CKD route. Taxation anomalies:  Duties on some select and key raw materials including steel and components are still pretty high and are thus hurting profit margins of the companies. Also, multiple tax rules that exist in different states are eroding the comparative advantage of a large domestic market thus making it important to implement VAT (Value Added Tax) as soon as possible.

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