The domestic cotton spinning industry is highly dependent on exports, particularly to China, with 30% of the yarn produced in India being exported, and China accounting for nearly one-third of the exports in recent years.
After a brief relief in January, pressure on export demand is resulting in a decline in cotton yarn realisations, stated an Icra analysis, adding that the contribution margins are likely to shrink again. The coronavirus outbreak in China has not even spared India’s cotton yarn exports, exerting pressure on yarn realisations, which have corrected by two-three% since the beginning of February. This was after a brief recovery in exports in January when the figures touched an estimated 100 million kg, in line with India’s historical monthly average, following a weak performance for nine consecutive months earlier, Icra noted.
The domestic cotton spinning industry is highly dependent on exports, particularly to China, with 30% of the yarn produced in India being exported, and China accounting for nearly one-third of the exports in recent years. The outbreak of the coronavirus in China and the consequent shutdowns in parts of the country have resulted in lockout of production units, resulting in lower demand for the yarn.
The resultant correction in realisations, even as cotton prices have remained relatively stable on the back of scaled-up market interventions by the Cotton Corporation of India Limited (CCI), are expected to contract spinners’ contribution margins again, vis-a-vis the previous three months. Movement in domestic prices contrasts with the international trend wherein uncertainties on demand have resulted in a sharper correction to cotton fibre prices in recent weeks.
As for the performance of the cotton spinning industry, it has already been severely constrained in the current fiscal year amid multiple headwinds, including a demand slowdown in the domestic as well as export markets and unfavourable raw material prices. While the industry was pinning hopes on a gradual recovery in yarn exports from Q4 FY2020 onwards, aided by the softening of domestic cotton prices, the recent developments could prolong tough times for the domestic spinners.
Jayanta Roy, senior vice-president and group head, Corporate Sector Ratings, Icra, said, “Even though domestic cotton fibre prices continue to be competitive vis-a-vis international cotton prices at present, with a price spread of 4% (reduced from 9% in February 20), a further correction in international prices amid demand-side uncertainties could leave domestic spinners uncompetitive in the international markets, similar to the situation which was witnessed in H1 FY2020.”
With no meaningful recovery in sight and continued uncertainty on the extent and duration of the impact of the coronavirus outbreak, Icra is maintaining the ‘negative’ outlook on the cotton spinning sector assigned in August 2019. There has been a visible weakening in credit profile of spinners in the current fiscal year, corroborated by a credit ratio (upgrade to downgrade) of 0.6 times in YTD FY2020,” Roy added.
The impact on contribution margins over the next few months could be lower for companies that have built up adequate cotton reserves at low prices in the recent months, have a wider geographical presence in markets other than China, and a focus on non-commodity and value-added products. According to the Icra estimates, operating profitability for the domestic spinning sector in FY2020 is expected at multi-year lows, closer to the level last witnessed in FY2012, when most players suffered sizeable losses on inventory due to a steep unexpected correction in cotton prices.
In contrast to the spinning segment, other segments of the domestic textile value chain are not highly dependent on China and other affected regions, for export demand. Nevertheless, some impact on production could be seen in segments such as fabric and apparels that are dependent on these affected regions for getting raw material supplies such as man-made fibres/ yarns, colours and dyes, chemicals and trims/ accessories such as zippers, buttons and needles.
Besides potentially affecting production for companies that do not maintain sizeable inventories, this could exert cost-side pressures for companies having limited flexibility to pass-on increases, amid a subdued demand scenario. The downstream segments, particularly apparels, could, in fact, benefit from the increased demand in the export market over medium- to long-term, as large customers look at geographically diversifying their supply base. No immediate benefit is expected because of the time required to scale up capacities and get approvals. Liquidity crunch is another challenge that the sector is currently experiencing amid delays in clearance of export incentives, the Icra analysis further said.