India's leading rating agency, ICRA Ltd believes that over the short to medium term the tractor industry is likely to face dual challenges of moderation in growth rates on one hand and large capacity additions on the other. Tractor volumes (domestic + export) are expected to slowdown in the last quarter, resulting in a volume growth in the region of 10-11% for full year of FY12. Over a five year time horizon, ICRA expects tractor volumes to grow at CAGR of 8-9%.

The Indian tractor industry has experienced strong volume growth during FY10-9mFY12 on the back of favourable cyclical and structural demand drivers. While tractor volumes remained robust through most of FY12 despite macro-economic headwinds; the domestic tractor market is showing some signs of weakness over the last couple of months. The demand-side economics in the tractor industry continue to find favour from factors such as support from the Government of India (GOI) towards agri-mechanisation; scarcity of farm labour; increase in credit flow to agriculture; increase in non-agri application of tractors; growth in niche power segments (<20HP and >50HP) and untapped territories; besides healthy export sales. However, off-late there are some concerns emerging over the earnings of farmers from the Rabi crop due to pressure on farm-gate prices; growing NPAs of tractor loans with public sector banks; and demand fatigue after strong sales growth during the last 2.5 years. Also food inflation coming off peak levels and lack of fiscal flexibility available with the government in the near future could have a bearing on the demand in tractor market.

Tractor OEMs are increasing their attention towards under-penetrated markets and roughly 50% of the incremental capacity expansion for the industry is expected to come up in South India. The domestic tractor industry is currently in a capacity augmentation phase and supply-demand dynamics of the industry are expected to change with the commissioning of large manufacturing capacity in FY13. Notwithstanding the possibility of deferment of capacity expansion by market participants in the backdrop of subdued demand conditions, increase in production capacity is likely to have a bearing on the pricing power of tractor OEMs, ultimately putting pressure on their profitability metrices. Apart from capacity build-up, with increasing penetration in the international market, Indian tractor OEMs are also expected to incur higher investments into R&D to meet global safety standards and emission norms.

Exports contribute about 11% to the total tractor sales of the country. Volumes saw a decline in FY09-FY10 on account of global economic downturn. Sales to overseas markets, however, staged a smart recovery in FY11 and the growth momentum continued in FY12. While Nepal, Bangladesh, Sri Lanka and the United States remain major export destinations, the expanding footprint of Indian tractor manufacturers in African and South-East Asian markets is expected to drive export growth over the medium-to-long term.

(For details, visit www.icra.in)