The fortunes of the auto ancillary sector are closely linked to those of the auto sector. Demand swings in any of the segments (cars, two-wheelers, commercial vehicles) have an impact on auto ancillary demand.

Demand is derived from original equipment manufacturers as well as the replacement market. Replacement demand accounts for close to 57 per cent of total demand, while OEMs account for 27 per cent, with exports accounting for the balance 16 per cent. 

Industry Wish List Excerpts from ACMA (Automotive Component Manufacturers Association of India) pre-budget memorandum Reduction in excise duties on components in small cars and two wheelers to 8%. Correction of inverted duty structure arising from the FTA (Free Trade Agreement) signed with Thailand. Introduction of specific tax incentives for attracting investments in the area of auto-components such as a tax holiday for auto-component industry for investments exceeding Rs 500 m and automobile industry in excess of Rs 5 bn. The industry should be brought under the purview of an incentive structure similar to what exists in some of the competing countries.  Budget over the years Budget 2004-05 Budget 2005-06 Budget 2006-07 Duty on key inputs such as non-alloy steel to be reduced from 15% to 10%. Duty on alloy steel, copper, lead, zinc and base metals also reduced from 20% to 15%. Consortium of banks formed to ensure speedy conclusion of loan agreements and implementation of infrastructure projects. 2% education cess on all taxes. Customs duty on lead cut to 5%. Excise duty on tyres, tubes and flaps reduced from 24% to 16% No change in excise duty on automobiles. Customs duty reduction on select capital goods and inverted duty structures (i.e., the duty on input costs being higher than the product itself) reduced from 15% to 5% or 10%. Customs duty on the basic plastic material reduced to 10%. Customs duty on selected petro-chemicals reduced from 10% to 5%. Customs duty on natural rubber maintained at 70%. But peak customs duty reduced from 20% to 15%. VAT implemented in majority of the states. Peak custom duty reduced from 15% to 12.5% Excise duty on cars having engine capacity upto 1,200 cc (petrol based engines) and 1,500 cc (diesel based engines) and length of the car upto 4,000 mm reduced from 24% to 16%. Continued thrust on road infrastructure Custom duty on alloy steel and non-ferrous (primary and secondary) metals reduced from 10% to 7.5% [Read more on Budget 2004-05] [Read more on Budget 2005-06] [Read more on Budget 2006-07]
Key Positives Huge potential: Global auto components market is worth over US$ 1 trillion and, considering India's market size, which is just 0.8% of the total market size, there exists tremendous growth opportunity for the domestic auto players to exploit. Having said that, the benefits will vary for Indian companies. We believe that players that have demonstrated their technical competence and have developed necessary scale are likely to benefit from global outsourcing opportunities. To give an example, around 75% of the total exports were to original equipment manufacturers (OEM) or TIER-1 players in 2006 as compared to around 35% in early 1990s. More than cost arbitrage: Due to cost related pressures on global auto players and Tier-1 suppliers, a lot of them have started outsourcing components from low cost countries like India, China and some of the Latin American and ASEAN countries. However, the technical capabilities of the Indian players have given them the edge in high precision and critical activities. The industry, which exported components worth over US$ 1.8 bn in 2005, is projected to grow at an impressive CAGR of 34% between 2005 and 2014. It is expected that the total exports will touch US$ 25 bn by 2014. Learning from the MNCs: The entry of global players such as Ford, GM, Toyota and Honda into the Indian market has allowed the Indian manufacturers to work with these players on global production, quality and delivery systems. It has also helped the global players to see for themselves the evolution of many auto components manufacturers and they are therefore now entrusting them (Indian companies) with more work. IT advantage: Thanks to the country's IT advantage, the industry is capable of becoming a full-fledged service provider (research, design, development, testing) to global OEMs and thus score over other low cost countries like China. This, combined with low cost quality manpower strengthens our stand in the global arena.		Key Negatives Lacking economies of scale: Despite being around 60 years old, the domestic auto ancillary industry is even behind countries like South Korea, Brazil and Mexico in terms of production and sales, thus depriving it the benefit of economies of scale. This makes it difficult for companies to invest extensively in R&D and development, a key competitive tool in the global market. Apart from this, the industry is highly fragmented, which also restricts the Indian players to develop scale (except for few players). Currently there are around 500 players (organised sector), which when compared to the total turnover of the industry indicates the fragmented nature of the same. Competitive threats: Though Indian players have demonstrated their technical competencies, countries like China can spring in surprises in the long run considering the fact that with global auto players increasing their presence in China, the next logical step would be to rise up the value chain (high end auto ancillaries). Increasing FTA: The growing number of FTAs (Free Trade Agreements) that are being signed by India with ASEAN countries is likely to hurt the domestic players as they pay a relatively higher excise duty of around 25% as compared to 1%-10% being paid by their ASEAN counterparts.

Equitymaster.com is one of India's premier finance portals. The web site offers a user-friendly portfolio tracker, a weekly buy/sell recommendation service and research reports on India's top companies.