Industrial convolution

Small and medium units have been hit the hardest by soaring raw material costs, exchange-rate volatility and cheap Chinese goods

Walk around Moradabad today, and you’d find it hard to understand why this was once considered India's brass city.’ This industrial centre in Uttar Pradesh, which was founded by Mughal emperor Shah Jahan’s son Murad early in the 17th Century, has now become more of an ‘aluminum city,’ having almost abandoned its brass heritage.
The shift has been swift. When brass prices started soaring, small-scale industries exporting artefacts to the West passed on the higher cost to end consumers. Meanwhile, the Chinese banked on huge volumes, copycat designs using brass-like materials, and, more importantly, government control over costs. Moreover, as Shailesh Chandra of RV Handicrafts points out: "The buyer isn’t attached to Indian artwork. If he gets a similar product at one-tenth the cost of the original, he’s happy." The result: demand for Moradabad’s artefacts slumped.
Almost 70% of the small-scale industries that fed the large export houses closed shop, consequently. Those who shifted to aluminum survived, but may have only delayed the inevitable. "Even aluminum prices are rising," says 50-year-old Haji Mohammad Saleem, owner of a small unit. "At best, it’ll be a couple of years before we close too."
In Ludhiana, another North Indian industrial hub, the situation is eerily similar to the one in Moradabad. The difference being that it’s steel and not brass that’s the commodity in question. Here, Sanjay Gupta’s 35-year-old cycle pedal-making unit is already history. "My clients were unwilling to take on the added burden," he says, referring to the soaring cost of steel.
Each day, over 5,000 small and medium enterprises (SMEs), employing more than 600,000 people, churn out about 40,000 bicycles in India’s bicycle capital. That bicycle economy is now under threat. "Steel costs have risen by about Rs 270 per cycle, while we have increased prices only by Rs 165. We are incurring a loss," says Charanjit Singh Vishwakarma, MD of Vishwakarma Industries and President of the United Cycle & Parts Manufacturers Association. One simple fact makes the picture crystal clear: steel sheets cost Rs 46,000 a tonne in India and Rs 32,000 in China.
Down South, the 5,200-plus members of the Coimbatore District Small Industries Association may not be on the verge of closure, but they’re certainly feeling the heat from rising commodity prices. "In March, our production loss was 15% due to non-availability of steel and other raw materials," says the association’s President, C Muthusami. "Margins will surely take a hit." In what was an unprecedented act for the association, its members took to the streets recently. They want the government to intervene and control raw material prices, a la the Dragon Nation. Says HP Kumar, Managing Director, National Small Industries Corporation (NSIC): "How long can China carry on with hidden subsidies? They will have to fall in line with WTO norms."
Moradabad’s Saleem echoes Muthusami’s views: "The policy changes and schemes don’t even touch us, and we are unaware of any move to bail us out. We just want metal prices to come down." Making a similar request, the South India Mills Association recently asked the government to regulate cotton exports, which it linked to soaring cotton prices (cotton prices contribute over a third of the cost of making yarn).
Mani Chinnaswamy, Partner at Appachi Cotton in Pollachi village, Tamil Nadu, says: "Cotton prices don’t look like they’re coming down much. There’s a crop failure every other day and consumption is soaring."
Seeking intervention from above
Although each of the stories highlighted above is disparate, the theme is the same. And, it tells us that small enterprises have got used to a stable cost environment all these years. When that stability is punctured violently, it is natural for them to look to the government to put things in order. This has something to do with the fact that SMEs have been a government priority for long. They account for almost 7% of India’s GDP.
Data from the office of the development commissioner indicates a 5.6% growth in the number of micro and small enterprises between 2006-07 and 2007-08, as well as a 3% increase in employment in these units. But perhaps the small units are expecting too much from the government. Ajay Sahai, Secretary-General, Federation of Indian Export Organisations, reckons that liberalisation and the new business environment have reduced the government’s ability to dole out sops.
It has to be said that small units are doing more than just seeking governmental intervention. There’s a sense that rising commodity prices are here to stay, and that a more practical approach is the need of the hour. The NSIC, for instance, is buying steel from the Steel Authority of India and selling it to SMEs that wouldn’t be able to reach long-term agreements with large steel makers on their own.
Interestingly, the Coimbatore District Small Industries Association is taking another look at a bulk purchase system that worked for it more than a decade back. It has requested the Small Industries Development Corporation of Tamil Nadu to carry out bulk purchases of materials on its behalf.
Challenges galore
Unfortunately for SMEs, commodity prices haven’t struck in isolation. You would expect an original equipment maker to have the ability to pass on cost increases. But that’s not the case. Take the example of Coimbatore-based Mahendra Pumps, which makes and sells pumps predominantly for the agri sector. Its Managing Director, Mahendra Ramdas, says: "We aren’t able to increase prices due to intense competition. Also, agri sector sales are sluggish because of a serious crisis in the sector." Hence, he expects annual revenue growth to slow down to 5-7% in the coming years, from 10-15% over the previous five years.
The hosiery and knitwear sector faces competition from across the border. Pramod Kumar Aggarwal, Director at Himker Knits, says there haven’t been any orders from European countries, including France and Germany, this year. "The absence of import duties on Bangladeshi products makes them 33% cheaper than Indian products, which attract a 14% import duty," says Aggarwal. "And economies of scale make Chinese products at least 20% cheaper."
The other problem that export-oriented industries, including textiles, faced over the last year was a sharply weakening dollar. Ramesh Kannan, CMD of Kaynes Technology, a Mysore-based provider of electronic manufacturing services, puts the issue in context: "SMEs don’t have rich surpluses and huge reserves, whereas big companies do." In the process of managing an unprecedented quantum of change in forex equations, some of the bigger companies got into exotic derivatives that they never understood, and incurred losses.
Though the rupee has weakened slightly, of late, there are many concerns on the forex front. "If you ask me the scenario for the next few years," says Ramdas of Mahendra Pumps, "I’d say it depends on how the rupee behaves." His view is that the rupee at 44 would be great for exports.
Finance doesn’t come easy either. Banks do not extend credit without securing some sort of collateral. Even though they operate in priority sectors, many small units do not approach financial institutions for loans due to the paperwork and processes involved. A general reluctance to give loans to this ‘high-risk’ sector also remains a cause of worry.
There’s some relief in sight with the NSIC roping in seven rating agencies, including Fitch, Dun & Bradstreet, and SMERA, to provide credit ratings to small enterprises. Under this plan, NSIC will reimburse 75% of the performance and credit rating fee levied by the agency to the enterprise. Banks have also been mandated to aim for 20% year-on-year growth in lending to SMEs. But banks and financial institutions are also under close scrutiny and responsible to their shareholders—they are unlikely to extend credit just because the government wants them to.
What adds to the gloom on the input front is the state of manpower. In many industries, manpower is getting expensive. As Roorkee-based consultant Hemant Arora points out: "The shortage of skilled labour has made SMEs a training ground for workers before they are poached by large corporates." And companies catering to the agri sector would like to see the manpower situation in the agri sector sorted out. Labourers are increasingly shunning farm work, preferring the higher wages they earn in the manufacturing or construction sectors instead. Many industries are seriously looking at automation as a partial solution to this problem.
The silver lining
Amid the cost-side assault on SMEs, there is some good news. Consumption is still good. "There certainly is demand," says D Bala Sundaram, Chairman of cast iron industrial components maker, CPC. He is also the President of the Indian Chamber of Commerce and Industry, Coimbatore. "Even if economic growth drops to 7%, that’s still good growth."
The smaller you are in the unorganised realm, the worse it is for you. And though things appear better in the organised space, Sanjay Agarwal, Executive Director (SME) of KPMG, reckons that small units’ ability to survive would be severely tested in a downturn. "They have to reinvent themselves."
That’s already happening. For instance, even in Moradabad, exporters like CL Gupta and Globe Metal Industries have quickly changed tack, and diversified into products made of glass and wood. They did this even as small units supporting artisans folded up.
In Coimbatore, companies are looking to get into newer markets or rising up the value chain. That, they say, is the only way for higher realisations, given that there isn’t much they can do to control costs. For instance, Bala Sundaram’s company is in the process of increasing manufacturing capacity by 60% to 800 tonnes. And the company is slowly bagging more value-added and high precision work. Says Jawhar Sircar, Development Commissioner, Micro, Small and Medium Enterprises: "The nimble and flexible nature of these players has enabled them to survive the vagaries of industrial change."
Mahendra’s Ramdas has two alternative markets. One is exports, which currently contributes only about 12% of his sales. He wants this to go up to 30% in the next five years. Secondly, he wants to look beyond agricultural pumps, and get into the housing sector aggressively.
Sharp Pumps’ chief Kannan Ramachandran wants to get into the high-margin game. He’s looking at a drastic shift from the current focus on the domestic and agricultural segments to industrial pumps. "Or else, it’s a volumes game. You need to get into the newer categories, otherwise you’ll be out of the market," he says.
New segments where large players aren’t venturing is the other destination for the SMEs. For instance, Zircon Products’ CS Gupta supplies zirconium powder to nuclear power plants. He also hopes to benefit from opportunities that would arise if the India-US nuclear deal is ratified. However, that doesn’t appear likely to happen any time soon.
Taking the inorganic route
Some players are also looking at acquisitions and joint ventures. Like the big players, they’ve been bitten by the M&A bug. And their stage for this mode of expansion is global. Companies like Ajanta Watch and Muzaffarnagar-based Bindal Duplex already have a China footprint, and others like Shivani Locks and Imperial Auto have European technology partners.
In fact, a British government delegation visited Lucknow and its surrounding areas in an attempt to get SMEs to form joint ventures, partnerships and alliances with British firms. However, by taking the inorganic route and increasing in size, many of these firms would cease to be SMEs, at least not by the government’s definition. They would thus cease to be eligible for government sops to the sector.
"We’ve gained confidence and are exploring opportunities," says DS Verma, President of Indian Industries Association of Lucknow. The size of some of these could be as small as Rs 1 crore. Understandably, therefore, the support from the investment banking fraternity is lacking. "The potential for M&As and consolidation is there, but most advisors are busy with big-ticket deals," contends KPMG’s Sanjay Agarwal.
Apart from the broad economic indicators, there is apprehension over the kind of government that will come to power after next year’s polls. That’s despite the fact that India’s top two political groups have a broad consensus on economic reforms.
Too much volatility in economic factors is surely a challenge for SMEs. But these units would do well to remember they’ve survived numerous changes in India’s economic landscape over the decades. Despite volatility in many sectors, India has been adding almost 200,000 new micro, medium and small enterprises every year, with the old giving way to the new.

Source: Outlook Business