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Third Edition of Knowledge Series for SMEs – Light Engineering and Automobile sector

Inflation print for the last two months suggests India has passed its inflation peak — Wholesale Price Index (WPI) inflation fell to -0.9% in April from 1.3% in March, while Consumer Price Index (CPI) inflation declined to 4.7% from 5.7%.

The slide in April inflation was driven by the base effect and a correction in commodity prices. To be sure, prices had spiked due to the Russia-Ukraine conflict during the same period last year, creating a favorable base effect. If monsoons do not play a spoilsport, we expect consumer inflation to average 5% this fiscal vs 6.7% last fiscal.

The Reserve Bank of India will, therefore, maintain its pause mode in the June policy — that’s the good news!

Nevertheless, the not-so-good news is slowdown in manufacturing and a sharper decline in merchandise exports.

Weak exports have a direct and quick impact on export-oriented domestic manufacturing. In addition, a moderate slowdown in domestic demand due to higher cost of borrowing will continue to temper manufacturing in the current fiscal.

Over the past three decades, despite various attempts to push manufacturing up, its share in gross domestic product (GDP) has risen only modestly. The bulk of the share shed by agriculture was picked up by services.

That said, services will continue to be the key diver of growth for two reasons. One, services already contribute 54% to India’s GDP, while manufacturing accounts for a mere 18%. Two, the domestic and global markets offer ample

opportunities for expansion of services.

After hiking the repo rate by a cumulative 250 basis points (bps) since May 2022, the Reserve Bank of India (RBI) pressed paused in its April policy meeting and kept the rate unchanged at 6.5%.

\

Merchandise trade (y-o-y growth %)

Feb-23 Mar-23 Apr-23

Exports 6.6 -7.2 -12.7

Imports -3.7 -8.2 -14.1

Trade balance -17.7 18.6 15.2

GDP (y-o-y %) Q1FY23 Q2FY23 Q3FY23 Private consumption 25.9 9.7 2.2 Government consumption 1.3 -4.4 -0.8 Fixed investment 20.1 10.4 8.3

GDP 13.5 6.3 4.4

FPI/FII net investments Dec-22 Jan-23 Feb-23 Rs billion 90.23 90.23 90.23

Exchange rate Feb-23 Mar-23 Apr-23

Rs/$ 81.9 82.3 82.0

Inflation (y-o-y %)

Feb-23 Mar-23 Apr-23

CPI 6.4 5.7 4.7

WPI 3.8 1.3 -0.92

Industrial output

(y-o-y %) Jan-22 Feb-23 Mar-23

Industrial (IIP) 4.3 5.8 1.1

Macro monitor

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s

Crude oil Natural gas

In April 2023, Crude oil price (Dated Brent) increased ~7.1%

m-o-m .It was primarily due to announcements of production cuts by OPEC+ leading to moderation global supply. Sharp production cuts resulted in supply pressures pushing crude oil prices northwards during the month

Decline in prices was primarily due to tepid demand, low buying response from North Asian buyers coupled with substantial inventory levels in China, Japan, and Korea.

Gold Steel basket

Gold prices rose as a softer dollar rekindled some of bullion’s appeal for overseas buyers, while investors braced for a host of U.S. economic data ahead of a crucial Federal Reserve policy.

Domestic CR prices remained stable to average between Rs 67,306-68,195 per ton. The market saw decline in the raw material prices along with disappointing export sentiments.

106 112 120 109

99 90 93 91

81 83 83 79 84

0 20 40 60 80 100 120 140

Apr-22 May-22 June-22 Jul-22 Aug-22 Sep-22 Oct-22 Nov-22 Dec-22 Jan-23 Feb-23 Mar-23 Apr-23

$/barrel

Dated Brent: International prices

8.6%

13.2%

-23.3%

-6.1%

-19.4%

-24.0%

-26.3%

0.0%

-14.3%

-30.0%

-25.0%

-20.0%

-15.0%

-10.0%

-5.0%

0.0%

5.0%

10.0%

15.0%

20.0%

Aug-22 Sep-22 Oct-22 Nov-22 Dec-22 Jan-23 Feb-23 Mar-23 Apr-23

On-month

Spot LNG

0.6%

-2.2%-0.1%

-0.1%

1.6%

-3.1%

1.0%

2.3%

4.5%

2.4%

0.8%

1.6%

4.4%

-4.0%

-3.0%

-2.0%

-1.0%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

Apr-22 May-22 June-22 July-22 Aug-22 Sep-22 Oct-22 Nov-22 Dec-22 Jan-23 Feb-23 Mar-23 Apr-23

On-month

Domestic gold price

5.1%

-5.4%

-10.2%

-4.6%

-1.5%

0.1%

0.9%

-1.7%

-1.5%

1.1%1.4% 2.1%

0.0%

-12.0%

-10.0%

-8.0%

-6.0%

-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

Apr-22 May-22 June-22 July-22 Aug-22 Sep-22 Oct-22 Nov-22 Dec-22 Jan-23 Feb-23 Mar-23 Apr-23

On-month

Domestic steel prices: CR coils

Movement in prices of key commodities

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US

Fed hikes interest rates

UK

Trade deficit narrows

• US GDP grew by an annualised 1.1% in the first quarter of 2023 according to the latest advance estimate released by the Bureau of Economic Analysis. The increase in GDP was driven by increases in consumer and government spending. This is the third consecutive quarter of growth in the US as the economy grew 3.1% and 2.6% (annualised), respectively, in the third and fourth quarters of 2022.

• UK’s GDP grew 0.1% in the first quarter of 2023, same as in the previous quarter. The manufacturing sector grew 0.5% on-quarter driven by growth in manufacturing of metals products (0.5%) and computer, electronic and optical products (0.2%). Services sector grew 0.1% as growth in IT services (1.2%) picked up.

China

Manufacturing contracts in China

Japan

Inflation softens

• The export sales sub-index fell sharply to 47.6 from 50.4 reflecting cooling global demand. Meanwhile, non-

manufacturing activity expanded for the fourth consecutive month, though the pace of expansion was softer than in the previous month. The NBS non-manufacturing PMI dropped to 56.4 from 58.2.

• April marked the sixth straight month where manufacturing activity contracted in Japan, but the pace of contraction was the softer than the previous month. Output levels continued to contract, indicating softening consumer demand.

EU

Eurozone inflation hardens

Impact on India

Losing steam in third quarter

• First quarter growth in major European economies printed mostly positive, with Italy (0.5%), Spain (0.5%) and France (0.2%) growing on-quarter. GDP growth was flat in Germany vs 0.5% contraction in the previous quarter.

Unemployment in the eurozone dipped to 6.5% in April from 6.6% in March.

• The ECB raised interest rates by 25 bps at its May policy meeting compared with a 50-bps hike in the previous three meetings.

• Real GDP growth was dragged down by slowing growth in key economies - which impacted India’s exports – as well as cooling domestic demand. Demand is expected to slow further as transmission of RBIs rate hikes continues and raises borrowing costs.

Global Snapshot

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Source: CRISIL Research

Automobile sector accounts for nearly 50% of demand across key light engineering segments

Opportunities for MSMEs in the Light Engineering industry

• Indirect benefit via PLI scheme in automobile: The government earmarked Rs 570 billion towards the automotive and auto- components sectors. Though, large players will be major beneficiary of the PLI scheme, PLI presents an indirect opportunity for MSMEs with greater domestic production and subsequent higher demand for ancillary industries such as light engineering.

• Demand from end-user industries to drive growth: Demand across key end-user industries such as automobile, infrastructure and general engineering segment is expected to remain healthy due to improved domestic demand and government focus on providing infra push. This will aid demand growth in Light Engineering sector.

Threats for MSMEs in the Light Engineering industry

• EV adoption: Proliferation of EVs poses a threat to the traditional Internal Combustion Engines (ICE). Major casted engine components such as cylinder heads, cylinder blocks, gear housing (these comprise around 50% of the casted components)

Ferrous castings Bearings

Steel Forging Fasteners Segment

40-50%

50-60%

30-40%

55-65%

SME share

Gears, pulleys, fly wheel, electric motor and castings, railing, finials, spindles

Deep groove, angular contact and thrust ball bearings, cylindrical, needle, taper and spherical roller bearings

Flanges, fittings, lap-joint stub-ends etc.

Nuts, bolts, studs, rivets and screws Products

Automobile, industrial machinery, power, chemical and fertilizer plants etc.

Automobile, electric motors, diesel engines, industrial machinery, machine tools and replacement market

Automobile accounts for bulk. Agricultural machinery, general industrial equipment, off-highway & railroad equipment are others

Automobile accounts for bulk. Consumer durables and railways are the other.

Key end-user industries

Sector snapshot: Light Engineering

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cylinder heads, cylinder blocks and gear housing will no longer be needed. Players would need to focus on newer products like stator housing, battery housing to offset the loss in demand for traditional casted products once EV demand picks up

Exports growth to moderate going forward Light Engineering top exporting destinations

Note: Top export/ import destinations are based on share of trade to respective countries in FY22 & FY23. On-year growth is for FY23 for exports/ imports

Light Engineering imports remained high in H1FY23 led by improved auto demand

Light Engineering top importing destinations

Regulations in the Light Engineering industry

FDI in Light Engineering: 100% FDI through automatic route has been allowed in the Light Engineering sector, which will help international players who are looking for growth opportunities in India to enter the segment.

1059 1072 1003 1097 1250 1099 1134 1193 10%

16%

-6%

18%

6%

-10%

-5%

0%

5%

10%

15%

20%

0 200 400 600 800 1000 1200 1400

Aug-22 Sep-22 Oct-22 Nov-22 Dec-22 Jan-23 Feb-23 Mar-23

(₹ crore) (%)

-

Exports (Rs crore) Light engineering exports

1529 1555 1467 1532 1599 1605 1459 1615 24%

20%

13% 15%

9%

14%

5%

19%

0%

5%

10%

15%

20%

25%

30%

1350 1400 1450 1500 1550 1600 1650

(₹ crore) (%)

Imports (Rs crore) Light engineering imports

Sector snapshot: Light Engineering

USA

FY22 export share

Y-o-y growth

Netherland Germany

China

UK 4%

82%

52%

100%

16%

65%

23%

15%

6%

4%

27%

15%

6%

3%

4%

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SME presence across value chain

Source: CRISIL MI&A Research

End-user sector snapshot – Auto component

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Key cluster of auto component

Parameter Units Pune Rajkot Aurangabad Chennai

Business Size

Turnover FY22 Rs

Bn 180-190 85-95 40-50 310-320

Business Profile

Key Product

Profile

Engines and Engine parts, Steering and transmission gears,

Breaking and Suspension systems,

Auto electrical and Auto electronics, Rubber parts, Plastic

molded items

Bearings, Precision components and

diesel engines, connecting rods,

pistons, cranks shafts, cam shafts,

liners, sleeves, air cooling products

Aluminum pressure die, casting, electrical

components, engines valves,

friction plate, diesel gen sets,

rubber molded components, shock absorber

and machines precision components

Engines and Engine parts,

Drive transmission and

steering parts, Suspension, and

breaking parts

Source: CRISIL research

Opportunities for auto-component MSMEs

• Increase in automobile demand: A growing population of working-class population and expanding middle class are expected to remain key demand drivers. Further, improved rural sentiments, a pickup in infrastructure activities and improved

affordability will aid demand across segments.

• Availability of labor: The presence of a large pool of skilled and semi-skilled workforce and a strong educational system.

Threats for auto-component MSMEs Higher exposure towards one vehicle segment

• Majority of the players cater to either OEMs present in passenger vehicle space, commercial vehicle, tractors or 2- wheelers

• This imposes a risk to the top line of auto component manufacturers when a slowdown hits a particular vehicle category

Regulatory and technological changes

• Change in the tax structure, government policies pertaining to emission norms or other regulatory requirements might affect the company’s business

• Regulators are mandating more safety and emission related features be included as a standard equipment in new models, adding to the cost

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Exports have been rising continuously Top exporting destinations

Imports have increased in December Top importing destinations

Note: Top export/ import destinations are based on share of trade to respective countries in FY22 & FY23. On-year growth is for FY23 for exports/ imports 4474 4507 4144 4623 5046 4413 4636 5170

13% 16%

9%

39%

17% 14% 14% 15%

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

0 1000 2000 3000 4000 5000 6000

(₹ Crore) (%)

-

Exports (Rs crore) Exports growth (%)

4032 3484 3572 3996 4048 3803 3482 4266 38%

26%

10%

30%

22%

27%

32% 30%

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

0 500 1000 1500 2000 2500 3000 3500 4000 4500

(₹ Crore) (%)

-

Imports (Rs crore) Imports growth (%)

End-user sector snapshot – Auto component

China

FY22 import share

Japan Korea

Germany

Thailand 7%

18%

13%

66%

78%

44%

21%

17%

13%

21%

17%

13%

6%

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Source: CRISIL research

A machine tool is used to shape metals or other rigid materials. Machine tools are critical equipment used in the manufacturing sector for basic and precision engineering work. The machine tools industry is considered an important subsector of the capital goods sector, supplying mainly to the automobile, auto component, aerospace, defense, and rail sectors.

Rationale for SME revenue growth

FY23FY24

❖Pre-election general election year will result in uptick in capex and strong demand from end user industries based on economic growth boosting revenues while stable/softening raw material costs to buoy margins.

❖Revenue to rise with uptick in demand emanating from rise in capex spends and strong demand from end user industries. Margins to see marginal uptick as raw material inflation cools off.

Industry expected to breach pre-covid levels in fiscal 2023 Rebound in end-use segments and capex push by government to drive revenue growth

FY22

SME Revenue Outlook

158 93:7 30-35%

Market Size (Rs bn) FY 22E Domestic : Export share Share of MSME in industry

12-17% 8-13%

FY23F FY24F

End-user sector snapshot – Machine Tools

Pipes [ippipes

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Exports have been declining continuously Top exporting destinations

Imports slowdown in December Top importing destinations

Disclaimer:

“CRISIL Research, a Division of CRISIL Limited (“CRISIL Research”) has taken due care and caution in preparing this Report. Information has been obtained by CRISIL from sources which it considers reliable. CSB Bank (“CSB”) is not involved in the preparation of the report and / or obtaining/assembling/verifying information as contained in the report in any manner whatsoever. CRISIL Research is exclusively involved in obtaining/assembling/verifying information and the subsequent preparation of the report. CRISIL Research and CSB do not guarantee the accuracy, adequacy or completeness of any information contained in the Report and are not responsible for any errors or omissions or for the results obtained from use thereof. CRISIL Research and CSB shall not be liable for decisions which may be based on this Report. Nothing contained herein shall constitute or be deemed to constitute an advice, an offer to sell/purchase or an invitation or solicitation to do so for any securities of any entity. CRISIL Research and CSB Bank especially state that they have no financial liability whatsoever to the customers/subscribers/ users (“Recipients”) of this Report arising from the use of any information that may be mentioned in this Report from time to time. Recipients of the information contained in the Report should exercise due care and caution (including obtaining of advice of tax/ legal/ accounting/financial/ other professionals) prior to taking any decision, acting or omitting to act, on the basis of the information / Report. No part of this Report may be published / reproduced in any form without CSB’s prior written approval or the relevant owner of the Intellectual Property Rights, as the case may be. All logos, trademarks and tradenames of CSB / CRISIL, respectively, belong to CSB and CRISIL only.”

6 8

19 26

9 10 11 11

8%

-49%

74%

302%

-67%

-23%

14% -1%

-100%

-50%

0%

50%

100%

150%

200%

250%

300%

350%

0 5 10 15 20 25 30

(₹ Crore) (%)

-

Exports (Rs crore) Exports growth (%)

66 87

57 184

76

114 96 76 14%

90%

-13%

165%

34% 32%

72%

20%

-40%

-20%

0%

20%

40%

60%

80%

100%

120%

140%

160%

180%

0 20 40 60 80 100 120 140 160 180 200

(₹ Crore) (%)

-

Imports (Rs crore) Imports growth (%)

USA

Mexico Italy

Korea

Bangladesh 4%

7%

26%

-93%

-80%

35%

8%

6%

4%

35%

9%

6%

0%

16%

China

Japan Germany

Belgium

Switzerland 6%

-6%

46%

112%

-45%

21%

22%

21%

15%

10%

15%

23%

24%

4%

5%