By Priyanka Venkat
The Indian spinning industry has once again sparked worries due to lacklustre demand and a subsequent poor contribution margin of producers. A recent report by the Investment Information and Credit Rating Agency of India (ICRA) highlights problems such as diminished exports and dwindling domestic demand that plague the sector. To understand the ailing situation, it is perhaps prudent to go to the basics and understand the issues faced by the industry.
Underlying factors influencing the sector
Raw material cost plays a large role in influencing the profitability of a spinning company, accounting for up to 55% of operating income. In general, to increase the contribution margin (the difference between sales price and variable costs), two options exist. A high input cost can be transferred to the customer by hiking up the sales price (which works favourably only when there is demand), or by lowering input costs so that the cost of production goes down, thus increasing the margin.
The spinning sector, however, does not have it easy. Realisations for spinning companies are from yarn and other finished products. Hiking up the sales price to offset currently high input costs (price of cotton) would require an adequate demand for the product, which does not exist at the moment. The firm cotton prices along with subdued demand, therefore, make it difficult for companies to improve their margins. The problem is further accentuated by the appreciation of the domestic currency, thereby making prices less competitive in the international market.
Poor demand situation and exports to China taking a hit
On the demand side, the industry has taken a massive hit with the fall in exports to China. China, being the main buyer of cotton yarn from India, has over the last three years reduced its import of cotton drastically. This is because of its policy that seeks to push consumption of domestic yarn and raw cotton. In April-December 2016, exports fell to 872.19 million kgs. This signifies a 12% fall in exports from 987.21 million kg in 2015 during the same period. Another reason for the declining exports is the increasing competition faced by India from Vietnam. Vietnam, being a signatory to the Trans-Pacific Partnership (TPP), has received investment in its spinning sector. This makes the country a more lucrative market for China and many Chinese companies have set up units in Vietnam. By outsourcing spinning related jobs to Vietnam, China can instead direct its labour resources to manufacturing high-value products and to its service sector.
Domestic demand, too, has been sluggish owing to uncertainty regarding GST implementation and demonetization. Inadequate demand and firm raw cotton prices have created a myriad of problems. The sluggish demand often forces small and medium companies to cut production in order to survive and also results in spinning units operating at diminished capacity. The inability to absorb fixed costs coupled with high holding costs from inventory build-up drastically impacts profitability.
Future not so bleak for the sector
All may not be lost for the sector. Favourable amounts of rainfall in important cotton-growing states such as Andhra Pradesh and Maharashtra, in addition to North India, will help boost cotton output. Cotton output is expected to increase by 10-15% in acreage in 2017-18, beginning from October. According to a statement by Jayanta Roy, the Senior Vice- President at ICRA, there is likely to be a cotton surplus resulting from an increase in global cotton production that will exceed consumption in CY 2018. The increase in supply will reduce the price of raw cotton, thereby reducing raw material costs for spinning companies. The lower input costs will help to improve their margin and set affordable sale prices. An increase in domestic demand is likely to be seen with the oncoming of the festive season.
U.S exit from TPP creates a positive possibility
Additionally, the exit of the U.S. from the TPP might prove to be favourable for India. Of course, the possibility exists that the member nations will continue with the partnership without the U.S. This will, however, be difficult, considering that many of the signatories agreed to the partnership in order to avail benefits from accessing the U.S. market. The spinning sector specifically, benefits from the non-materialization of the TPP. The yarn forward rule imposed by the TPP on member nations could harm exports for the Indian spinning industry. Under the rule, in order to avail the benefit of low duties, they need to mandatorily import yarn and other inputs only from other member nations of the partnership. This minimizes the chance of any those member nations importing yarn from India, as they could get it elsewhere at a lower cost.
Concrete action needs to be taken by the industry to diversify its export base. At the same time, accurate estimates of crop production could help in stabilizing raw material prices by allowing spinners to forecast input requirements beforehand. This, along with agricultural measures taken by the government to ensure a steady supply of raw cotton, could go a long way in easing the suffering of one of the most important sectors in the country.
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