9 July, 2024 15:28:50 IST 
While the Indian chemical industry has for much of the last decade been an outperformer in comparison to its global counterparts and to other industrial sectors in the country, that has changed in the last three years. Weak demand in global markets, rising costs of feedstock and growing competitive pressures have come to bear heavily on the Indian chemical industry, adversely impacting margins and profitability.
While some segments of the industry have been more impacted than others, none has been immune. Though there are some early signs of recovery in overseas demand as companies are beginning to replenish depleted inventories, there is uncertainty on whether this will endure and put the industry back on track to better profitability.
Challenging three years
According to an analysis by McKinsey, a consultancy, India’s chemical industry reported growth in Total Shareholder Returns (TSR) of 20% CAGR in the period from 2014 to 2023, even as global peers reported just 8.5%. This has been attributed to strong growth in the domestic market (albeit from a low volume base), as well as success in global markets. The latter has come about by mainly leveraging on a low-cost position (especially for fine and speciality chemicals) and a culture of process innovation.
The TSR of the chemical industry also outperformed the local Sensex TSR (representing the broader economy), which grew at a CAGR of 13% in the period from 2014 to 2023.
Since 2020, however, the picture has changed significantly. While the Sensex TSR grew by 16% CAGR between 2020 and 2023, the chemicals business reported just 9% growth. However, this was still better than the growth in TSR in other major industry segments, and nearly twice the average for the global chemical industry.
In short, the chemical industry underperformed other industrial sectors in India – both upstream and downstream of it – but did better than its peers overseas.
Declining margins
The TSR decline seen in the last few years was largely caused by margin declines, which, on average, fell from 12% in 2020, to 10% in 2023. This happened even as revenue growth clocked 17%, compared to 11% between 2017 and 2020. This seems a quirk but can be explained by the fact that much of the rise was accounted for by price increases brought about by rising costs of raw materials, mainly petroleum derived.
Reversing the situation and putting the industry back on a faster growth trajectory (as measured by TSR), will hinge on a recovery in margins. This has two drivers – the first, external to a company and determined largely by global market conditions; and the second, internal and operational.
External factors
The global state-of-affairs in the chemicals business can be summed up as follows: stalling global demand, consequent to a slowdown in the largest market for chemicals, viz. China, compounded by the travails in Western Europe; severe overcapacity following an investment binge (mainly in China) in most value chains; and dim prospects for demand growth in an economic outlook that sees per capita consumption slackening from its historical pace.
As a result, even as domestic consumption of chemicals has more or less held up in the last two years in India, exports have shown annual declines of about 4%. This can be attributed to demand slowdown in the major economies that India exports to, as also a rise in self-sufficiency in some. The latter is most evident in petrochemicals, wherein India’s trade balance (imports minus exports) has increased from $22-bn in 2019 to $30-bn in 2023, driven both by an 8% fall in exports and a matching rise in imports to meet the growing needs of the domestic market.
The rise in imports in large measure reflects the inability of the domestic industry to raise capacity to meet incremental local demand. This is well exemplified by the case of polyvinyl chloride (PVC) for which India has the dubious distinction of being the world’s largest importer. The decline in exports of petrochemicals such as para-xylene and benzene are consequent to the rise in self-sufficiency in China.
While the business of fine and speciality chemicals plays to India’s strengths and exports from this sub-segment of the chemical industry will stay a key driver of overall export growth, it too has not been immune to global trends. Exports have dropped in the last three years due the industry-wide destocking (which is still to fully play out, according to some), as well as supply chain constraints.
In the wake of Covid, which exposed the vulnerabilities of supply chains to damaging disruptions, there are calls to build internal capabilities in critical industries (drugs and pharmaceuticals being one) in the EU and in the US. While their impacts may not be evident for some more time, this is an aspect that should worry businesses here.
About half of India’s exports of chemicals goes to Europe and the Asia-Pacific region and demand growth in both regions has been mute of late. While in the former consumption growth has slowed to a piffling 1%, in the latter it is down to 4% (from 10%), pulled down by the slowdown in China, even as manufacturing capacity there continues to rise. According to McKinsey’s analysis, China is expected to add 22-mtpa of new capacity for propylene and 30-mtpa for ethylene in the near term – which will be matched by investments in downstream olefin-consuming sectors. This will have two consequences: fall in imports in the value chains in which these investments take place; and steeper competition for Indian chemical companies both in the domestic and export markets.
What can be done?
The challenging outlook for the Indian chemical industry calls for a greater focus on improving competitiveness, and McKinsey recommends a five-pronged approach: striving for functional excellence using digital tools and analytics; becoming truly global; accelerating application-based innovation and product development; focusing
on sustainability; and deepening and globalizing the talent pool.
Indian companies have traditionally underinvested in building functional excellence through adoption of digital and analytics-based performance improvement. This, the consultancy believes, can enhance annual EBITDA by 400-500 basis points. It cites the example of a ‘digital and analytics leader in petrochemicals and refining’ who achieved around 10% annual EBITDA impact through 20 advanced analytics use cases, ranging from yield and throughput improvement using sensors, to quality improvement through predictive modelling and in-process traceability. Aspects of business that could benefit greatly from improved analytics include dynamic pricing to better combat volatility in prices for raw materials; value-based pricing (particularly relevant for speciality chemicals); more efficient procurement through the use of data-driven models for predicting price movements; and improved supply chain management thanks to better demand forecasting.
Building a strong global presence, including through acquisitions, enhanced supply chain infrastructure, application development capabilities and deep regulatory understanding can boost revenues by 10-30%.
Innovation – especially product innovation (in contrast to process innovation) – has been a weak spot in the Indian chemical industry, and that needs to change. The business of speciality chemicals is all about understanding customer needs and offering bespoke solutions, and this is a path few companies have taken so far. Product offerings with improved sustainability profiles also afford a sizeable path to profitable growth but call for substantial investments in innovation and serious commitment from senior management for the long term. These could take the form of green alternatives to existing chemicals, for example, by substituting fossil fuel derived raw materials with bio-based ones.
While India is well placed to make this transition thanks to its extensive agricultural base, product choices need to be made judiciously. The first-generation bio-feedstocks – mainly starches, sugars and vegetable oils & fats – are intimately linked to the food chain and hence not sustainable options, except as an interim measure till something better comes along. The newer generation options come from agricultural wastes (lignocellulosic biomass) and algae, and while they are scalable, several technical challenges still need to be overcome.
India’s chemical industry (like many other industry sectors) can benefit from the low construction costs compared to the competition, but much of this stems from a labour arbitrage that comes into play only when procurement and engineering is done locally. This is the case for most fine & speciality chemicals, where basic process technologies are locally available, as are facilities for the design and engineering of most equipment. In the capital-intensive bulk chemicals business this is not the case. For one, process technology for many large-volume chemicals is still not available locally (think ammonia, ethylene, caustic soda, etc.), and procuring them from abroad comes with stiff licensing fees that can make all the difference to overall project costs. On the other hand, most plants for active pharmaceutical ingredients or technical agrochemicals are built based on indigenously developed knowhow – either within the companies themselves or through collaborations with publicly-funded research laboratories.
In summary, the cost competitiveness Indian chemical industry is clearly evident in fine and speciality chemicals. These segments – far removed from a barrel of crude oil – play to India’s strength and do not expose the country’s weaknesses. They have already made a mark globally, and recent geopolitical developments point to a greater role for them in the years ahead. Every effort must be made to reinforce their competitiveness.
