The outbreak of COVID-19 and its spread has taught us some important lessons in life. One important lesson leant by Indian manufacturers is the risk of depending on one source (and that too a source in China) for their material supply. Even the Prime Minister has called for Aatma Nirbhar Bharat (self-reliant India) reminding us the government’s policy of 60s and 70s (then to save precious foreign exchange). This time of course the reason is to reduce risk of sourcing materials from others especially in times of emergencies.
ACs & electronic items have highest import content
Manufacturing of air conditioners is one of the few sectors which will be shaken up by the new policy of self-reliance. ACs along with other electronic items are the items where import content is the highest and the government’s aim is it to reduce this import content by half in next five years. The government is contemplating to increase import duties on compressors and air conditioners to improve indigenization.
China a dominant player in AC market
However, the task is easier said than done as our AC manufacturers till now were largely dependent on imported components as the domestic volume was not attractive to reap the benefits economies of scale. In the case of compressors, only Highly (A Chinese company) has a manufacturing facility with 2.5mn units capacity, and GMCC is setting up a facility in Pune (delayed due to Covid-19 outbreak) with an initial capacity of 1mn units. In addition, the majority of components required for compressors are still getting imported from China. It should be noted that China enjoys 36% share in global RAC exports. It has strong component ecosystem with large manufacturing scale which will always remain an advantage. China is one of the largest manufacturers of RAC compressors, and shifting this out of China would not be an easy task and may not happen in the near future despite the best efforts by the government and our industry.
China enjoys economies of scale
Because of its huge scale, China enjoys benefits of economies of scale and can sell its products competitively in the international market. At present, 75% of compressors are imported from China, rest being sourced from countries like Korea, Thailand, Indonesia and others. According to some experts, India needs to manufacture 20-25mn units (as against present domestic demand of 5million units annually). However, in the coming days there may be a shift for IDUs from China while compressors will continue to be imported.
Countries adopting ‘China plus one’ policy
However recent pandemic and subsequent supply disruption of components and materials due to closure of manufacturing units in China has alerted countries who have been depending upon Chinese manufacturers for their components and materials. Most of them are now adopting China ‘plus one’ strategy to reduce their dependence on China.
In calendar year 2019, China’s export of RAC (room air conditioners) in global markets amounted to USD 16.2 billion accounting for 35.5% share in global RAC exports. On the other hand, USA is the largest importer of RACs, with a total value of USD9bn (CY18), implying a global import share of 19%. However, the recent Tariff barriers by the US on Chinese products and China ‘plus one’ strategy could potentially benefit Indian contract manufactures if any volume shift happens from China. Even a 5-10% shift from China could mean huge opportunity for the Indian players.
The Indian government’s move toward increasing import duties on compressors would also be critical to manage cost arbitrage for the domestic AC manufacturers as compared with China. However, given the sheer manufacturing scale in China, India would have limited scope of any cost advantage over china, at least in short to medium term.
But opportunity is knocking at our door
However, for India there is an opportunity waiting which needs to exploited. Rising labour costs and the global trade war are forcing various global brands to adopt a China ‘plus one’ strategy. India could be one of the beneficiaries from this shift, with a favourable policy structure to develop a manufacturing ecosystem, lower corporate tax rate and lower cost of labour. India has competitors too like Vietnam waiting to grab the opportunity. However, the vast domestic market is an added advantage for India which its competitors lack.