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Week Dec 14 - Dec 18, 2015

Electronic goods: Demand set to surpass oil bill by 2020

India is one of the largest growing electronics markets in the world with an estimated size of US$69.6 billion in 2012. With a CAGR of 24%, it is expected to surpass the US$400 billion mark by 2020E. However, sharp growth in demand for electronic goods is unlikely to translate to higher domestic production, which is currently at US$32.7 billion and likely to cross US$104 billion by 2022E. While the domestic industry will cater to only a fourth of this demand, India will still need to import goods worth US$300 billion, roughly equivalent to the country’s oil import bill. Till 2015, electronics imports at US$37 billion were the third highest import item next only to crude and gold. However, in the first six months of FY16, the import bill of electronics goods (at ~US$16 billion) has already surpassed total gold import (at ~US$15 billion) and is behind only the total oil import bill. Now, India is staring at an import nightmare of an unprecedented rise in proportion of electronic goods that can push the country into a spiral of high imports. This would necessarily entail higher external and internal borrowings and does not bode well for India’s economy in the long term.
 

 India faces structural trade deficit problems

 In the last 15 years, India’s current account deficit (CAD) has been in focus, along with its fiscal deficit. During FY01-15, India’s total import bill grew at a CAGR of 16.8% to US$448 billion in FY15 largely driven by petroleum products and gold, which recorded a CAGR of 16.8% and 16.4%, respectively. During the same period, exports grew at a CAGR of 14.8% in FY01-15 from to US$310 billion in FY15. To address the rising trade deficit, GoI and RBI took a few decisions to curtail local demand in the petroleum and gold sectors to reduce their imports and, hence, the deficit. Meanwhile, with the recent decline in crude oil prices and diminishing allure of gold, a few problems have automatically got addressed. This has reduced the contribution of crude and gold in the total import bill by ~200 bps in FY15 to 30.9% and 8.7%, respectively, compared to FY13. However, looking at the recent trend, the contribution of electronic goods in the total import bill has increased 150 bps to 8.2% in FY15 compared to FY13. With the rising trend of digitisation, it is likely that the contribution of electronics goods to the total import bill would increase significantly and may surpass the gold and oil bill, going ahead.

India’s trade data

Source: ministry of commerce, ICICI Securities
 

 Import of major three items

Source: ministry of commerce,  ICICI Securities
 

Electronic imports to amplify structural trade deficit problems

With an import bill of US$37 billion in FY15, electronic goods comprised 8.2% of total imports making it the third most valued category of imports after petroleum products (30.9%) and gold (8.7%). In the last 15 years, the import bill of electronics goods recorded a CAGR of 18.3%, higher than the import bill of petroleum products and gold, which grew at a CAGR of 16.8% and 16.4%, respectively. India’s electronic goods production was inadequate to meet demand due to deficiency in skill level to compete with imported products. Hence, to meet the rising demand, India is heavily dependent on import of electronics goods from China, US and other South East Asian regions. If we dig deep, the main reason behind the rising import of electronic goods is shortfall in domestic production. Local production faces a substantial cost disadvantage constraining investment in plants and equipment, technology absorption, development capability and innovation. Given the weakness in domestic production, India’s growing demand for electronic products results in rising imports. Currently, imports account for 65% of India’s consumption of electronic products in India, up from 63.6% in FY11. At the current growth rate, the demand-supply gap for electronics goods is projected to accelerate further from US$25 billion in FY09 to US$296 billion in FY20. This is expected to result in a sharp increase in trade deficit, going forward. Considering the current scenario, to reach the US$400 billion mark by FY20, domestic production would need to grow 37% annually in FY13-20, a daunting task indeed.
 

Projected demand supply gap of electronics goods

Source: Industry, ICICI Securities
 

Import of total electronics items in India

Source: Industry, ICICI Securities
 

Proportion of phone instruments and mobile phones in total import

Source: Industry, ICICI Securities
 

Domestic manufacturing lags behind import

Electronics manufacturing in India is struggling despite huge and rapidly growing domestic demand. Local electronics manufacturing, especially in ‘chip-designing’ facility have remained disconnected from global networks of innovations and productions, resulting in rising imports of final products and dependency on imports for key components. Over the years, local manufacturers faced barriers in the form of restrictive regulations and a largely poor implementation of past policies, which stymied investments in plants and equipment, technology absorption and innovations. This could be attributed to high cost of finance at ~11-13% (cost of fund) against 2-4% globally, high power cost due to irregular power supply, etc. This, coupled with higher tax imposed by the Indian government, makes manufacturing of electronic products unviable in the country. For example, India currently has a tax rate of 16% with a value added tax of anywhere between 4% and 12% depending on the state, on PCs and servers manufactured in the country. However, the duty on imported PCs is a mere 17.42%, which makes imports much more viable than domestic manufacturing of electronic products. India also signed the Information Technology Agreement (ITA) with the World Trade Organisation in 1997, which compelled the country to reduce import duties to zero on several electronic products, including servers and desktops.

Currently, 65% of demand for electronic products is met by imports while even the balance 35%, which is manufactured in India, is mainly ‘low value added manufacturing’. Unlike China and other low cost manufacturing Asian countries, India has to shift gears from relying exclusively on “high-volume, low-cost” manufacture to pursue a niche market strategy by focusing on “low volume, high cost” products.
 

Source: IESA
 

Focused approach to yield better results

The Indian electronic industry (~US$70 billion) is considered to be one of the largest growing electronics markets in the world but constitutes just 0.7% of the global electronic industry. Hence, it is miniscule by global standards. As far as Indian electronic products consumption pattern is concerned, top five products that contribute ~60% of total electronic consumption are: mobile phones (~40%), flat panel TVs (~9%), laptops (~6%) and desktop (~5%). Among major electronic products, the semiconductor design industry and LED are expected to record fastest growth at a CAGR of 25% and 108% in FY12-20E, respectively. Looking at the rising demand for circuit based high value products and near absence of domestic manufacturing, it has now become essential for India to become strong in electronic systems and integrated circuit design to provide a strong base for manufacturing “low-volume, high value” electronic products. To make this possible, India would need to develop circuit design-and-development capabilities (which is largely done by MNCs currently), with India based companies serving India’s domestic market. India’s fragmented innovation system, characterised by weak links between education, research and industry, makes the task even more challenging. The government’s National Policy on Electronics is an important step to address this issue.
 

Indian Electronics Market: Top 20 Products by TM Revenues (2012)

 

 

Source: IBEF, ICICI Securities
 

Leap from consumer to manufacturer imperative for long term growth

The Indian electronics industry is at a huge inflection point. From being predominantly consumption driven, the electronics industry has major potential to transform to a manufacturing industry. However, for sustaining structural long term growth, the Indian manufacturing sector needs to match global standards. Concentrated efforts are required on part of both the government and the industry to develop the Indian electronics industry into one of the critical GDP contributors in the near future. In the recent past, global companies have got attracted to India on the back of continuous effort on part of the government and a relatively low cost structure. Companies from around the world are looking to build local capabilities in India not just to serve the domestic market but also to cater to overseas markets. Hence, identification of high priority product markets and holistic development of the ecosystem can potentially solve all the woes of the Indian electronic system design & manufacturing industry.
 

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