INDIA SPECIAL Seizing India’s capital-goods opportunity
India’s
domestic capital-goods sector is under-developed, weighed down by low
investment in technology and talent. That may be changing.
As India has emerged as the
world’s fastest-growing large economy, it’s no surprise that demand for capital
goods has more than doubled in the past decade. Yet one-third of this demand
has been met by imports: India imported machinery worth more than $30 billion
in 2015, making it the fourth-largest import category after crude oil,
electronics, and gold. For a $2 trillion economy, the country’s capital-goods
sector remains relatively underdeveloped, offering a significant business
opportunity for both Indian and foreign original-equipment manufacturers
(OEMs).
India’s domestic capital-goods industry is weighed down
by low investment in technology and talent. Most companies focus on
low-value-add fabrication and assembly work, unable to move up the chain with
their designs or technology. Value addition represents only about 22 percent of
total output, or $13 billion, and the capital-goods sector as a whole accounts
for just 0.6 percent of India’s GDP, compared with 4.1 percent for China, 3.4
percent for Germany, and 2.8 percent for South Korea . The output of domestic
capital-goods players grew by an average of 2 percent annually from 2010 to
2015, trailing the overall average of 7 percent annual economic growth.
Yet change may be on the horizon. Accelerated
economic reforms have created new opportunities in
the capital-goods sector, with new policies lowering barriers for domestic and
foreign investment as well as for partnerships. India’s ranking on the World
Economic Forum’s Global Competitiveness Report climbed to 55 in 2015–16, from
71 a year earlier. Encouraging manufacturing of capital goods is a critical
component of the “Make in India” program.
Seven areas of
opportunity
India has much
more to offer global investors than just low-cost labor:
OEMs can tap into the large and growing local market, build on the educated
workforce, and use this base to serve global markets. We estimate that India
offers 8 to 10 percent growth in the capital-goods sector, compared with 2 to 4
percent in developed markets, and have identified seven segments that could
result in a $30 billion annual revenue opportunity. If the capital-goods sector
develops as we envision, it could deliver annual earnings of about $3 billion
to $4 billion and create up to five million jobs.
1. Environmental
solutions
Deteriorating air quality has forced India’s policy
makers to tighten emission laws. These new requirements could result in a wave
of capital expenditure on effluent control and cleantech.
We estimate thermal power plants will need to spend roughly $15 billion on
emission-control equipment such as flue-gas desulphurization and catalytic
reduction over the next five to seven years. Management of industrial water
will require output water treatment and recycling and reuse systems (the
government has already committed $3 billion for the Clean Ganga project to
clean India’s longest river). Oil refineries upgrading equipment to meet new
emission standards will require investments of up to $5 billion during the next
five years. Technical collaboration between foreign OEMs, which bring in the
technology, and Indian manufacturers, which can customize it for users, could
work well.
2. Building logistics
infrastructure
Higher public spending on infrastructure and
transportation, particularly on rail, roads, and ports, is a government
priority. Spending on
railways is expected to double to more
than $15 billion a year1—rolling-stock
investments will account for about $4 billion of that total, while tracks,
electrification, and station upgrades will also be major areas of investment.
Large capital-goods makers could set up coach and locomotive manufacturing
facilities in collaboration with the railways, while smaller companies could
supply components and subassemblies like bogie castings, underframes, and
superstructures. City metro systems are being built across India, with more
than ten projects under way or planned. We expect global metro-car
manufacturers to start using India as a manufacturing hub and estimate the market
at $2 billion a year by 2020. The country is set to double its port capacity
over the next decade, with an estimated $15 billion investment in as many as
six new megaports and upgrades of existing facilities. And highway construction
has already more than doubled to over 20 kilometers per day in the past two
years, providing opportunities for material handling equipment,
construction-equipment manufacturers, and engineering, procurement, and
construction providers.
3. Aerospace and
defense
India is estimated to require a total defense investment
of $150 billion, with two-thirds made in the next eight years. In addition, the
country’s 2016 defense-procurement policy requires certain percentages of
indigenous manufacturing, offering opportunities for smaller domestic vendors
to ally with major global players and for tier-two and tier-three vendors as
public-sector defense-manufacturing enterprises outsource production to meet
demand. Defense production is a vast arena, and identifying high-potential
niches like airframe machining and composites manufacturing could well be a
prerequisite for success. Entrants should be prepared for long gestation
periods and rigorous prequalification requirements. Partnerships between global
OEMs and Indian companies can be a faster go-to-market route.
4. Urbanization
Metropolitan cities with more than a million people are
India’s engines of growth. The McKinsey Global Institute estimates that India will have
69 such cities by 2025, and they require modern
waste-management solutions such as waste-to-energy, water
solutions like advanced water treatment and desalination, modern information-
and communications-technology systems, and upgrades to existing urban
transport. This market will only grow as cities expand, and investment is
already supported by a fund of nearly $15 billion under the Smart Cities
mission and Atal Mission for Rejuvenation and Urban Transformation scheme.
5. Power generation
and distribution
Investment is flowing into renewable power generation,
transmission, and distribution infrastructure as new thermal power capacity
takes a back seat. We expect 80 to 100 gigawatts of renewable energy to be
added by 2025, much of it from increased solar capacity. This growth provides
opportunities for engineering, procurement, and construction companies as well
as package and component suppliers. The market is ripe for
efficiency-improvement systems such as tracking solutions for solar power, but
their adoption will ultimately depend on the cost-benefit payoffs. Coal
production and thermal power generation in India have ramped up, but
transmission and distribution infrastructure is the new bottleneck. We expect
investment in grid upgrades, renewable-energy integration, rural
electrification, and smart metering. There will likely be a trend toward more automation
and advanced-analytics-based solutions for controlling high transmission and
distribution losses. These and related opportunities would need annual
investment of about $10 billion by 2020.
6. Basic materials
In line with targets to reduce the country’s dependence
on imported coal, Coal India Limited increased its output from 452 million
metric tons in 2012–13 to 539 million metric tons in 2015–16. There is also a
strong emphasis on beneficiation of coal. This will generate opportunities for
technology upgrades such as high-capacity mining equipment, continuous miners,
and automated material handling.
The cement business, which is currently oversupplied, is
expected to get a boost from the infrastructure buildout. About 80 to 100 metric
tons per annum is expected to be added over the next five years. These
investments could generate an estimated opportunity of $5 billion for
cement-machinery players.
7. Food and
agricultural infrastructure
Food consumption in India is estimated to grow at 5
percent annually—and crop yields will need to increase to meet this demand.
Fertilizer demand is projected to grow from 26 million metric tons of nutrients
to 27 to 29 million metric tons by 2020. Farm mechanization in India is low, at
0.8 horsepower per hectare, compared with 1.6 in Vietnam and Thailand, and 4.1
in China. The need for increasing
agricultural productivity is expected to drive more
mechanization. The government has allocated $350 million in the current
five-year plan (2012 to 2017) to promote the use of machinery by farmers. On
the consumer side, the trend toward processed and ready-to-eat food will
generate opportunities for food-processing equipment manufacturers.
Inhibitors to growth
These seven areas are by no means a comprehensive
assessment of the opportunities in India’s capital-goods sector, but we believe
they are among the most significant. To exploit them fully, companies need to
address roadblocks that have impeded growth in the past, and many are
intertwined:
Risk of falling behind on technology. R&D
expenditure by Indian capital-goods players is about 0.5 percent of annual
revenue, on average, compared with about 5 to 6 percent in Germany.
Technologies are either imported or licensed from global OEMs, while Indian
companies are fabricators or assemblers.
Inadequate investments to capture growth. Incumbents
invest too little in growth—about $2.5 billion a year, representing 19 percent
of value added, around half the broader-economy average of 36 percent. The
industrial-goods sector has attracted few new enterprises, for example, while
high cyclicity in end-use industries (such as thermal power) often deters
long-term investments.
Inability to attract talent. The
best technical and managerial talent often favors the services sector and other
manufacturing sectors such as automotive.
Weak component supplier base. There
is a shortage of high-quality component suppliers. For example, high-end
machine spindles still need to be imported to meet demand.
Limited industry–government engagement. The
capital-goods sector has not sufficiently leveraged the potential of
government-to-government engagements.
India’s
capital-goods sector has been hampered by several factors and trailed growth in
the broader economy, yet multiple trends are creating opportunities. While the
potential gains could be significant with regard to not only profit but also
job creation, fully benefiting will require Indian companies, foreign OEMs, and
policy makers to work together.
By
Abhishek Agrawal and Suvojoy Sengupta
http://www.mckinsey.com/global-themes/india/seizing-indias-capital-goods-opportunity?cid=other-eml-alt-mip-mck-oth-1701
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