10 known-unknowns for Indian Capital Goods Sector in 2021

1.      Power demand growth rate: any change beyond 5% can change sector outlook

Demand for power has been subdued during last five years leading to an impression of oversupply and nearly zero-deficit. During FY15-20, annual demand grew by an average of 3.9% against 5.2% during FY10-15, and just 1.3% during FY20. At the current pace of demand growth, India has sufficient generation capacity for the next 4-5 years- installed and in pipeline, together. However, any change in excess of 5% can give traction to new conventional capacity additions.

2.      Utilization factor of conventional power plants: change +/- 5% will have extreme impact

India had conventional power generation capacity of 100 GW in 2003-04. It added 100 GW in just 10 years, leading to a capacity of 200 GW in 2012-13, unfortunately coinciding with the period of demand contraction. This lead to underutilization of assets. During FY15-20, average utilization of thermal power plants was 60% against 70% during preceding five years. Resulting stress in the sector led to bankruptcy of many promoters/investors. Gradual improvement in utilization towards 70% may bring renewed interest among investors.

3.      HC/SC judgment on privatization of Chandigarh discom will define story of power reforms in future

India has seen major reforms in power sector, starting delicensing of thermal power generation in 2004 and tariff-based competitive bidding (TBCB) for power procurement in 2011. Unfortunately, last end of the power value chain which is distribution has not seen significant reforms leading to AT&C losses in excess of 20% (World average 8.6%; Delhi 8.4%) and extreme financial stress on DISCOMs.

To usher in efficiency, the government in May 2020 had announced that power departments and distribution utilities in UTs will be privatized by January 2021, with Chandigarh (profitable, AT&C losses<15%) as the first UT with the long-term objective to provide a model for emulation by other utilities across the country.

The High Court of Punjab and Haryana has put in abeyance the privatization of the Chandigarh DISCOM, following protests from its engineers and other workers on the ground of employment scheme and reservation policy.

Observations of the HC/SC will set the tone for privatization of DISCOMS in the country. Successful privatization of DISCOMs may become next major driver of growth in the power sector by bringing new investments and technologies.

4.      Bailout for financially stressed DISCOMs: Will it revitalize sector

Currently, DISCOMs' outstanding dues to power GENCOs has crossed one lakh crore. This financial strain of DISCOMs have not only hit power producers but have also added stress to the banking sector.

Government is contemplating giving a stimulus in the form of a loan. This move will help DISCOMS clear their dues with electricity generating companies, who in turn can clear their dues with suppliers. Consequently, it will ease the working capital woes of the manufacturing industry, suppliers, vendors, and miners. The entire value chain of electricity generation and consumption may become viable again for all stakeholders involved.

This may catapult much awaited investment in emission control systems from the State GENCOs.

5.      India’s Hydrogen Policy: Will it add one more element of uncertainty

India plans to build green hydrogen plants that will run on electricity produced by green energy sources and help reduce dependence on fossil fuels for mobility. They can provide grid-scale storage solutions, and provide feedstock for ammonia production.

Prime Minister Narendra Modi on 26 Nov 2020 announced plans to launch a National Hydrogen Energy Mission, buttressing India’s green energy credentials with the carbon emission-free next-generation fuel. Specific policy document from GoI is awaited.

As per current workings, green hydrogen is not likely to become viable before 2030. However, any aggressive posture by GoI will add one more element of uncertainty for the industry who is already swaying back and forth among multiple possibilities.

6.      Ingot-to-Cell manufacturing in India: will it happen

India currently has around 8 GW and 3 GWs of solar module and cell manufacturing capacity respectively. To meet its growing demand for solar power, India imports close to 90% of its solar cells and module demand, of which 80% is from China. In FY17, FY18, and FY19 solar imports from China stood at $2,817.34 million, $3,418.96 million, and $1,694.04 million. 

With an objective to relieve this heavy dependence on Chinese imports, Indian has been looking for indigenization of complete solar value chain. The government introduced slew of measures to grow the solar PV manufacturing like capex incentive, domestic content during 2007-2015 and safeguard duty, mandatory BIS certification in 2018, but without much success.

Encouraged by the success of production-linked incentive (PLI) in sectors such as large scale electronics including mobiles (incentive of 4-6% on incremental sales), the government is going to introduce PLI incentives together with the above enabling factors, with an objective to provide much-needed impetus (localization, scale and technology) to push domestic manufacturing in the Indian Solar industry.

Success of above may usher in new energy in the manufacturing sector.

7.      Implications of import-restrictions & possibly next commodity super-cycle in terms of tariff & execution

Indian capital goods industry is poised for two major headwinds in terms of their cost structure.

Around 20% of the raw materials for the industry is ferrous including various types of steel. The steel prices are consistently moving northwards leading to the expectations of next commodity super cycle. During the earlier cycle 2000-2007, when the commodity metal index increased by 3.3x, the direct material cost for the industry as per cent of sales increased by an average of 500 bps.

Next, GoI has put in place various restrictions on imports from China to encourage domestic manufacturing. As a result, industry has started facing the cost escalations due to supply shortage and resultant compulsive imports from high-cost destinations like Europe.

For instance, as per media reports the cost of imported solar modules has increased by 22% since June 2020 due to various reasons including trade restrictions with China.

Going forward, above two factors may increase cost of power gear and hence cost of generation.

8.      Outcome of COP26: Is India going to declare net zero-carbon target for better optics

COP26 is scheduled to be held in Glasgow, Scotland during November 1-12, 2021 under the presidency of UK. This conference is the first time that countries are expected to commit to enhanced ambition since COP21. The IPCC claims that to have a 50% chance of keeping global warming in check, global emissions need to reach net zero by 2050. Net-zero refers to balancing the amount of emitted GHG with the equivalent emissions that are either offset or sequestered.

The countries Sweden, UK, France, Denmark, New Zealand, Hungary, Japan, South Korea, and China have declared a net-zero target by 2050 (2060 for China). To meet net-zero carbon goals, the countries have to aggressively decarbonize their power and industrial sectors of coal and oil, and their transportation sector of petrol and diesel. It also means improving the energy efficiency of industries, modernizing the grid, expanding renewables generation and investing in hydrogen and carbon capture technologies.

Declaration by India in the run up to COP26, may expedite ongoing energy transition and hence the structural change in capital goods’ demand-mix.

9.      Exit of more OEMs from coal power plants: Is global market moving towards oligopoly

Out of 2125 GW of global coal based power generation capacity, more than 70% capacity is less than 30 years old, the useful life of a power plant (733 GW <10 yrs/ 540 GW<10-20 yrs/ 231 GW<20-30 yrs) with substantial share from SE Asia.

GE, Siemens, and Toshiba, the major global OEMs have declared their exit plans from coal based power generation value chain. If other OEMs like Mitsubishi, Doosan too follows their global peers, the global equipment manufacturing may move towards oligopoly, generating new stream of spares and service opportunities for remaining industry players.

10.  Disinvestment of BEML: Will the new promoter create a new industrial giant

The government, which currently holds a 54.03% equity stake in BEML has initiated the process to divest 26% equity stake in the company by way of strategic disinvestment along with transfer of management control. The equipment manufacturing company with good footprints in mining & construction, rail & metro, and defence & aerospace can potentially become a major capital goods players, post divestment.