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Why investments in cotton yarn make sense today

Sanjay Kumar Jain

The removal of quotas on January 1, 2005 has ushered in a new era in world textiles. This move has created to a large extent a level playing field for all players in the industry/countries. In other words the need for a sustainable global competitiveness can never be overemphasized as today our economy is being integrated with the world economy. Local problems cannot be an excuse for being uncompetitive - and no one can save a company, there will be no government, no restrictive policies to protect a unit/company. However differential tariffs and regional trade agreements would keep influencing the movement of goods and trade flow for times to come.

In anticipation of removal of quantitative restrictions, countries like China and to a lesser extent India had started building capacities and preparing itself to increase it share in the global textile market. There is an expected restructuring of the sourcing strategies of the developed countries and economics are seen to be the main driver of deciding where to buy. The textile manufacturing base is fast falling in Europe and North America and Asian and African countries are filling up the gap at an increasing pace - the removal of quotas has hastened the process, as there are no limitations on quantities purchased from any country.

China was expected and is the largest beneficiary of the new order in the textiles world. They have been installing capacities at a rapid pace in anticipation since 1999 and today have the capacity to make huge supplies at very competitive rates to the developed world. In short they are the first choice of every buyer. India did not plan its expansion in a systematic way and the industry/government only woke up in 2004 to the impending opportunity. The result? The gap between China and India has become so large, that it is unfair to call India No.2 player in the global textile industry. However, as the saying goes: “Do not put all your eggs in one basket”, every large buyer wants to diversify its sourcing base and countries like India/Pakistan/Bangladesh are a ready choice depending on the type of item.

It is clear that the textile world of manufacturing is undergoing restructuring and new buying strategies are evolving. Textile clusters are getting stronger around a limited number of countries. India is gaining because of its strong textile background on both technical and raw material base - it is the second best alternative to China especially for cotton textiles - yarn/fabric/garments. However things are not as rosy as it seems and sounds. Pre-2005, many Indian suppliers who held quotas were able to get premium equivalent to the quota prices for their products. They overnight lost that, leading to a reduction in their realizations. There has been a drop in prices due to removal of quota in order to match prices of China and other low cost countries - this however has been coupled with volumetric growth in garment orders. Orders are increasing from the West, but prices are very tight (as that is the incentive to come to India).

This pressure on garment suppliers to deliver more and more - means more demand for downstream raw materials like fabric and yarn. India’s base of manmade fibres is not very strong and hence India does not have a cost advantage on this side, hence import of blended fabric would grow from China/Pakistan/Indonesia/Thailand. However on the cotton side, India is very strong. India has a large and growing raw cotton fibre base, which is more than sufficient to meet, expected future demand of the industry. Hence this is where opportunities lie. There would be tremendous demand pull for cotton yarn and fabric from the garment industry. India is one of the lowest cost manufacturers of cotton based raw materials in the world and the Indian garment industry would be largely dependent on the domestic industry for its needs. This would lead to a major expansion of domestic demand for cotton yarn/fabric in India. Today, India has 40% market share of the global combed yarn trade - however with the growing need of quality yarn by the domestic industry, exports would be replaced by domestic sales. Realisations in export sales are 3-5% lower than domestic sales, however due to lack of volume demand companies had to export. This scenario is fast changing, which means that margins for quality yarn manufacturing companies would go up. Further it is important to note that gestation/lead time for garment/fabric unit is 6 months, while for a yarn unit it is 18-24 months - hence there would be a mismatch in growth of capacity in these two sectors leading to a tight yarn supply situation leading to upward pressure on prices. An example of this is China, which is still importing a lot of cotton yarn to meet its demand of fabric/garments.

Today, India has about 37 million spindles out of which maybe about 25 million spindles are worthy to give quality yarn. The two main suppliers of spindles in India have a maximum capacity of 2 million spindles, hence we cannot add more than 8% yarn capacity annually unless we go for Chinese machinery - which is yet to be tested or used in India and whose quality delivery is under question (Indian yarn is expected to be better than Chinese yarn in terms of consistency and quality). The government is envisaging multiple fold growth for textiles exports in the next 5 to 10 years, and not to forget the growing domestic market - this means major pressure on downstream inputs which are more commodities in nature - fibre and yarn. As it is well known the price-demand elasticity for commodity type products is very high and this means the yarn industry can see very high upward movement of prices in the coming few years.

To summarise and highlight the investment rationale for cotton yarn:

• Garments are registering strong growth, but prices have been under pressure and have fallen post 2004
• Yarn realizations are 3-5% higher in domestic market vis-à-vis exports
• There is a shift in demand from exports to domestic for cotton yarn
• Lead time for increasing garment/fabric production is much lower than yarn production - lead to mismatch of demand /supply of cotton yarn
• There is a 12-18 months waiting for yarn machinery supply
• Price elasticity of raw cotton and yarn is much more than garments - high growth would mean pressure on garments due to higher input prices which cannot be necessarily passed on in the short term
• Interest costs are 3% due to TUF subsidy from the government - yarn is the most capital intensive process in the textile chain. This facility is available only till 2007 - removal of this would lead to a temporary halt in yarn spinning capacity coming up (this would protect the industry from danger of over-supply).

The author is joint managing director, T T Limited, India.