Economics Analysis of Managerial Applications

Impact of Rupee Appreciation and Inflation on Indian

Textile and Garment Industry

Submitted to:

Ms. Gulnar Sharma

Submitted by:

Bhavik Gandhi (M/FMS/08/10)

National Institute of Fashion Technology, Mumbai.

A Stronger Rupee Tests the Fabric of
India's Textile Exporters
These are troubled times for India's textile industry. As the rupee appreciates
against the U.S. dollar, more and more small and medium-size firms are
laying off workers or closing down. Industry experts say that in the southern
textile hubs of Tirupur and Bangalore, a factory closes every week. Premal
Udani, chairman of the Clothing Manufacturers Association of India,
estimates that 500,000 to 600,000 jobs are at risk. As exporters struggle to
secure profitable orders, the Ministry of Textiles' $25.06 billion export target
for the fiscal year seems well beyond reach.

While the rupee has appreciated more than 15% compared with the dollar
over the last year and a half, competing countries' currencies have not
appreciated correspondingly. "Our currency is destined to appreciate," said
Anees Noorani, vice chairman and managing director of Zodiac Clothing, one
of India's leading brands in men's shirts and ties. "But does the appreciation
have to be as sudden or sharp as from 47 rupees to 39 rupees between July
2006 and now?"

The troubles come amid slackened demand from the Western consumer.
With U.S. economic growth slowing, U.S. retailers have offered deep
discounts. That has left India's exporters squeezed by customers who want
more for less and by a currency whose appreciation provides less when they
do make sales. "Our competitiveness for the time being has gone away,"
said P.D. Patodia, chairman of the Confederation of Indian Textile Industry.
The association estimates that for every 1% fall in the value of
the dollar compared with the rupee, profit falls by 1.2%. "Some exporters will
be permanently damaged and not all will survive," said Subir Gokarn, chief
economist for Standard & Poor's Asia-Pacific. This isn't the first time prices
have shrunk. Free on board prices fell two years ago when quotas imposed
by the Multifiber Arrangement were lifted. India's ready-made garment
exporters, who contributed 3% of the global clothing trade, responded by
boosting export values 30%. Ready-made garments now account for 43% of
India's textile exports. "Exporters were helped in reducing costs by the
disappearance of the quota premium expense," Udani said. "This time
around the dollar is in a free fall, so exporters can't plan anything." The
United States is the largest buyer of Indian textiles and apparel, at 19% and
33%, respectively. That helps explain the degree of pain the dollar's fall has
inflicted. Apparel and textiles together contribute more than 30% of India's
net export earnings.

Supplier Consolidation
The currency-driven troubles come at an already-challenging time. Retailers
are using a smaller number of vendors, bypassing traditional buying houses
to source directly from a few chosen manufacturers.
Committing large sums for expansion requires nerves of steel.
"Unfortunately, interest rates overall in India, too, have moved up, from
7.5%-8% to 12%-13% per annum," said Rakesh Valecha, director of
corporate ratings at Fitch Ratings India. So after a federal government
interest subsidy for upgrading certain machinery, "the effective cost for
exporters has gone up from 2%-3% per annum to 7%-8% per annum." India
is not well-suited for high-volume, low-margin production, Zodiac Clothing's
Noorani said. "We have not built the kind of scale that Vietnam or China has.
Nor do we have the productivity to compete with the best. I therefore feel
that India has missed the bus with respect to this part of the textile
outsourcing business. You can see that vendors of Wal-Mart and the like are
now in distress and we have a crisis."

As recently as 2006, India, among the top five apparel exporters, seemed to
be making rapid strides. The new outlook is a sea change from industry
projections of exports doubling every year. "Today we are nowhere on that
trajectory and are in fact selling at prices which are lower than what we sold
at even five years ago," Udani said. Many small firms operate at net profit
margins between 3% and 8%. "Thanks to low gross margins, any production
loss quickly turns into a net loss as well," the Textile Industry Confederation's
Patodia said.

The industry's woes have led some prominent participants to leave or scale
back. In August, the Hinduja family, who controlled 70.1% of Gokaldas
Exports, sold a 50.1% stake to the Blackstone Group, the private equity firm.
Captain C.P. Krishnan Nair, chairman of the Bombay Stock Exchange-listed
Hotel Leela Venture, sold his family firm Leela Scottish Lace. The textile firm
had helped keep him afloat when the hotel industry and Hotel Leela's
fortunes in particular were in the dumps several years ago. The company
that made 12 million pieces annually with revenue of 4 billion rupees was
sold to Bombay Rayon Fashions for 1.55 billion rupees in July.

Seeking Political Patronage

The apparel and textile sector is India's largest employer after agriculture,
with an estimated workforce of more than six million. So job losses are a
political hot potato. The industry is looking for government help while it
adjusts to the rupee's appreciation.
"We need a global level playing field with comparable infrastructure, interest
rates, power costs and labor laws," Udani said. It costs more to ship a
container from Tirupur to the western port city of Mumbai than it does to
ship one from Chennai, in southern India, to Hong Kong, he said. Responding
to industry demands, Shankersinh Vaghela, the minister of textiles,
announced in November a 10% reduction on export credit guarantee
premiums, a 10% to 40% increase in prevailing duty drawback rates, and a 2
percentage point reduction in pre-shipment and post-shipment credit
interest
rates. The government also released about six billion rupees to clear all
arrears of terminal excise duties and central sales tax reimbursements. To
spur the sector's modernization, the government also offers a credit-linked
capital subsidy, covering about 10% of eligible capital investments, in
addition to a five percentage point interest cost reimbursement on loans
taken to invest in specified advanced machinery and equipment. S&P's
Gokarn says the fiscal measures are inadequate. "Exporters are holding the
dollar price line but are getting hit on the rupee margins, and that has banks
scared to fund them," he said.

Recent news media reports suggest that banks are less willing to extend
foreign currency loans as they get swept up in a global flight to safety.
Textile exporters are demanding more from the government, which they
believe has not paid sufficient attention to their interests when negotiating
free trade agreements. India doesn't have bilateral agreements with the
United States or the European Union, its largest markets, to help bring down
import duties on its most prominent items, Udani said. "On the other hand,
several countries in Africa and even neighbors such as Bangladesh have
such agreements in place. Instead, the free trade agreements that we have
signed so far are with Far Eastern countries that get beneficial access to our
large domestic market for textiles." Noorani said, though, that the
government had recognized the urgency in starting discussions with the
European Union for a bilateral agreement. In the interim, the industry wants
the government to allow hiring on a contract basis so it can expand or
downsize operations based on market government to allow hiring on a
contract basis so it can expand or downsize operations based on market
conditions.

Reengineering to Survive

Textile exporters are employing a range of management strategies to

survive. After purchasing Leela Lace, Bombay Rayon Fashions plans to
expand its garment capacity almost threefold in the coming years. "Larger
companies can use scale to invest in newer machinery which has better
quality, higher productivity and finds increased acceptability with
consumers," Fitch Ratings' Valecha said. "Such equipment also needs less
manpower. Scale advantages can also be realized with respect to freight and
logistics and the purchase of key raw materials such as cotton." Udani
estimates that scale economies can help companies lower costs by 5% to
10%. A bigger scale of operations also helps as producers woo customers
looking to consolidate their relationships from hundreds of suppliers to just a
dozen or so with global capabilities. Companies are also seeking to integrate
across the value chain. Firms such as Alok Industries which once were known
as process houses now not only process fabric but also produce finished bed
linen, quilts and bed covers, and shirts and trousers too. "If you are at the
lower end of the value chain, then your ability to get price hikes is severely
limited," Valecha said. Companies are also trying to add niche value-added
material to their product mix. "If you want to sell plain blue shirts, then you
need to give your buyer an offer that's comparable to other country
suppliers, and that's getting difficult," said Saurabh Kumar Tayal, chairman
of KSL & Industries. "On the other hand, if you are selling shirts with beading
and embroidery, embedded with Swarovski crystals, then you can command
some value, and the EBITDA margins can be as high as 50%." To do this,
however, requires a complement of good merchandisers, the ability to supply
a range of colors and a large roster of customers. "Creating a buyer takes
time. It could even be years," said Patodia, who in addition to his role as
chairman of the Textile Industry Confederation is vice chairman and
managing director of Prime Textiles. The days when exporters could pack a
couple of samples in suitcases, catch a plane and come back with orders are
over. "Today we are getting orders for value-added garments, but these
aggregate to only 30% of our capacity," said Udani, who runs a midsize
garment export unit. He said breakeven levels of production for the
industry's garment units are around 50% to 55% of capacity. To increase
orders, exporters are seeking clients in the European Union. This strategy
helps diversify market and currency risk, but it offers peculiar challenges. "In
the EU, every member country has a different fashion and style, and
therefore orders tend to be fragmented," Udani said. Vendors who already
have clients with EU operations are trying to switch the billing currency for
exports from the dollar to the euro, at least for merchandise dispatched to
the Eurozone. The transition from being commodity producers to suppliers of
value-added products requires skilled managers. "There is a huge gap in the
availability and requirement of personnel particularly in the areas of apparel
management, merchandising, vendor management and retail specific to the
apparel industry," said Vijay Agarwal, chairman of the Apparel Export
Promotion Council. "It is estimated that at junior, middle and senior level,
there is a dearth of almost 250,000 managers in this sector." Amit Goyal,
president of the Confederation of Indian Apparel Exporters, said that "the
entire textile value chain needs to be strengthened. Setting up fashion hubs
in the country, with the latest collection ranging from textile accessories to
the finished products, is required." The Textile Ministry is planning to create
textile "investment regions" that it hopes can help reduce transaction costs
and enhance competitiveness by removing procedural bottlenecks. Most
Indian companies are accustomed to steadily rising costs. This requires
continuous process improvements and more intelligent use of scale. "Firms
need to source their raw materials from dollar areas, control and drive costs
down, increase productivity by balancing technology and reduce expenses
by using energy-efficient methods of production," Noorani said. "We have
invested heavily in production systems and deskilling of operations by
engineering the product on machines." Companies are also addressing
financial management. "Exporters have become conscious of the currency
risk and are not leaving their books open," Valecha said. "They are either
purchasing a forward cover or building a natural hedge via imports."

Look Inward
Some firms have decided it's time to use the ultimate safety net: a domestic
market estimated to be worth almost $30 billion. This has come not a
moment too soon, as several low-cost countries – including China, Turkey,
Vietnam, Pakistan, Sri Lanka and Bangladesh -- are finding the Indian market
more attractive, thanks to the rupee's appreciation. "We believe low-end
export goods could find their way to domestic markets in the current rupee
scenario, and this could dampen prices," said Ashish Jagnani, an analyst with
Citigroup.

Fortunately for textile exporters, the Indian consumer is increasingly

demanding quality, and Indian companies are increasingly positioned to
deliver. "The quality available in India has improved so that the average
Indian no longer seeks to buy a shirt made overseas," Patodia said. It is at
least as profitable to supply to the domestic market as it is to export, said
Noorani. A problem with catering to the domestic market, however, is the
lack of customers that can place orders as large as Wal-Mart, Gap or JC
Penney can. Still, large Indian retailers such as Shopper's Stop and Pantaloon
Retail have set up sourcing operations around China. Domestic textile firms
need to build their franchises and relationships with the domestic retail
chains that in coming years could provide a substantial source of business.
Some large textile firms are even launching their own apparel brands in the
Indian market, following the examples of Raymond and Arvind Mills. Others
are going a step further. Welspun is setting up a chain of home textile stores
under the name "Spaces." Alok is setting up a textile and apparel retail chain
branded "H&A." Such retail strategies also present challenges. Firms
planning dedicated retail chains must contend with consumer preference
shifting in favor of multibrand outlets. And attracting customers loyal to their
exclusive stores won't happen overnight. "This is a long gestation business
that takes capital," Tayal said. "The minimum breakeven period for a store is
one year." Some firms that have ventured into retail chains are finding rising
commercial real estate prices an impediment to their ability to roll out with
the speed to attain critical mass. Building a brand in an already competitive
market, thanks to the presence of international brands such as Arrow and
home-grown brands such as Zodiac and Provogue, requires perseverance.
"It's not easy if all you have been doing is selling fabric and yarn," Fitch
Ratings' Valecha said. "This requires a different mind-set, expertise and skills
sets, and the ability to take additional risks. It could take years to establish
brands." The saving grace is that textile companies may have a better
chance of building a brand that connects with Indian consumers than one
that connects with consumers overseas. Some Indian firms are acquiring
companies in the developed world. These are either retail chains or
marketing agents they have traditionally sold to. The silk yarn and fabrics
maker Himatsingka Seide in October bought U.S.-based DWI Holdings for $30
million. DWI, which has the license for marketing brands including Calvin
Klein, Barbara Barry and Royal Sateen, had revenues of $47 million in fiscal
2007.

In August, Alok Industries, through its wholly owned subsidiary Alok

Industries International, signed an exclusive license agreement with AISLE 5
of New York for its portfolio of lifestyle brands -- aworld and Cotton + Clay.
Under the multiyear license, the company acquired the manufacturing and
distribution rights of bath, sleep, dining and home decor textile products sold
through supermarkets in the United States and Canada. In April, Alok bought
60% of Czech firm Mileta, which has established relationships with premium
customers for its high-end cotton fabrics. Welspun bought a controlling stake
in British home textile firm Christy in July 2006 to gain a wider presence in
the United Kingdom. Home textiles firm GHCL in February 2007 bought New
Jersey-based home textiles manufacturer and distributor Best Manufacturing
Group for $35 million, and in July 2006 acquired Rosebys, a British home
textile retail chain, for $50 million.

India's inflation rate rises marginally to 12.91

percent, prices seen stabilizing
India's wholesale price index (WPI)-based inflation rate rose marginally to a new high of 12.91
percent in the 12 months to July 5, higher than previous week's figure of 11.89 percent, government
data showed on Thursday.

The inflation rate, though the highest since annual numbers in the current series became available in
April 1995, has brought cheer to the people who are optimistic that the inflation rate would be
moderating soon.
According to government figures, primary articles index decreased by 0.1 percent, with food articles
decreasing by 0.2 percent.

In the primary articles group, out of a total of 98 articles, 13 articles showed a decline in prices while
prices of 57 articles remained stable.

However, index of fuel, power, light and lubricants rose by 0.5 percent and that of manufactured
products by 0.3 percent.

In the fuel, power, light and lubricants group, there was a decline in prices of LPG but the prices of
aviation turbine fuel (ATF), furnace oil, light diesel oil and naphtha rose on the back of rising crude
oil prices.

In the manufactured products category, food products showed a decline of 0.5 percent but textiles
and chemicals & chemical products rose by 0.1 percent and 0.5 percent respectively.

What is most encouraging is that the annual inflation rate for the group of 30 essential commodities
declined to 5.74 percent from 5.98 percent in the week ended June 28. Prices of commodities like
food grains, pulses, edible oils, vegetables, dairy products and some other commodities, including
kerosene, soap and safety matches stabilized.

The WPI is India's most closely watched cost-of-living monitor as unlike the consumer price index
(CPI), which is published monthly, the WPI covers greater number of products in its computation and
is published weekly.

Inflation rate is expected to high in double-digit figure for a few more months before moderating.

Analysts have blamed India's high inflation on high oil and food prices globally and feel that
inflationary pressures would continue for some time.

"It is slightly below expectations but it doesn't change the fact that inflation pressures are still strong,
and clearly the trend in revisions still remains worrying. In all, it is encouraging but not something
that gives a lot of comfort," said Vikas Agarwal, research head, JP Morgan Chase, Mumbai.

"You need to see more such trends before one can convincingly say that we have seen the worse
behind us," Agarwal said.
According to Saugata Bhattacharya, economist, Axis Bank, Mumbai, the inflation rate rose due to
high oil prices. "I believe the push has come more from the fuel group than primary commodities. I
do not see much impact of food commodities on the headline number," he said.

"It is a surprise...but I am not comfortable with this level," said Siddhartha Sanyal, economist with
brokerage Edelweiss Securities. "It does not indicate an easing of prices."

Agrees Rupa Rege Nitsure, chief economist, Bank of Baroda, Mumbai. According to Nitsure,
inflation is showing "some easing on a week-on-week basis" but it does not indicate any trend of
decline in prices.

"This is not an indication of an inward trend. I still maintain that inflation will peak at about 14.5
percent, as the demand-pull pressures are still quite strong," Nitsure said, adding that a poor
monsoon season and 10 percent hike in domestic fuel prices last month would add to the pressure.

Though the rise in inflation rate was "slightly below expectations and suggests that there has been
some moderation in the inflation momentum due to a decline in primary article prices," Sonal Varma,
economist at Lehman Brothers, Mumbai, said that manufactured product prices continue to surge
ahead, suggesting that producers are raising output prices.

"Risk of second-round effects of inflation have risen," Varma said, adding that it might prompt
Reserve Bank of India (RBI), India's central bank, to further tighten monetary supply in the financial
market.

Last month the Reserve Bank of India (RBI) moved to hike the repo rate, or the key lending rate at
which the central bank lends funds to commercial banks, from 8 percent to 8.50 percent, the highest
in 6 years, and the cash reserve ratio (CRR) or the proportion of reserves the commercial banks
must keep with the central bank, from 8.25 percent to 8.75 percent to tame inflation.

The bank is expected to act again when it meets on July 29 for its quarterly policy review.

While Bhattacharya and Nitsure feels RBI would hike the repo rate by 25 basis points (bps) or 0.25
percent, Varma has not ruled out a more "aggressive" 50 bps hike.

Last time when RBI hiked the key rates, it termed its action "somewhat painful," but said it would
continue its "heightened vigil" and would be focused on inflation management.

Meanwhile, Finance Minister P. Chidambaram has expressed satisfaction over the effects of
monetary measures taken by RBI, saying, "There are signs that monetary steps are taking effect."
"Inflation, on a week-on-week basis, has stabilized. M3 (money supply growth) is slowing down,"
Chidambaram said on Thursday.

However, the finance minister warned that inflationary pressures would continue to remain for some
more time before moderating.

High inflation has become the bugbear of the ruling coalition government that faces the risk of
angering the people ahead of a crucial election next year.

Earlier this week, Prime Minister Manmohan Singh confessed curbing inflation and maintaining
growth momentum was a major challenge for the government as it is "influenced by global factors."

Singh, however, said the government had taken a number of measures to rein in inflation and prices
would moderate with time.

To tame inflation, the government has announced a slew of fiscal measures like scrapping import
duty on crude edible oils, banning export of non-basmati rice and pulses, and banning futures
trading in essential commodities like rubber, chana, potato and soya, even as it urged steel and
cement producers not to raise prices.

However, the global investment banker Barclays Capital has warned in a report that India's inflation
could surge to 17 percent by September as the government is likely to hike fuel prices between 10
and 20 percent again within 2-3 months to limit fiscal risks.

Meanwhile, domestic ratings agency Crisil has projected that India's economy would grow at 7.8
percent in the current fiscal year.

However, think tank Center for Monitoring Indian Economy (CMIE) said in its monthly review on
Thursday that India's economy could grow at 9.5 percent in the current fiscal year, boosted by the
industry and services sector that would grow at 11.4 percent and 10.6 percent respectively.

International Monetary Fund or IMF has also revised its projections, saying, Thursday, that India's
economy would grow at 8 percent in 2008. IMF earlier estimated India's economic growth at 7.9
percent for the current fiscal year.

In 2007, India's economy grew by 9.3 percent.

Inflation spirals to 16-yr high, touches 12.63%

22 Aug, 2008, 0114 hrs IST, ET Bureau
NEW DELHI: Costlier food items, such as fruits, vegetables and milk, pushed the wholesale
price-based inflation to 12.63% for the week-ended August 9, from 12.44% in the previous
week. The inflation stood at 4.24% in the corresponding week of the previous year.

While Masur prices rose 3%, tea, moong and gram prices increased 2% and milk was up 1%
over the last week. Overall index for primary food articles, which has weightage of 22.02% in
the WPI, rose by 0.3% in the week ended August 9. Inflation stood at 12.44% (provisional) a
week ago. Also, in keeping with the trend of final inflation coming higher than provision
estimate, inflation for the week ended June 14, 2008 has been revised to 11.80% from 11.42%.

Economists feel inflation could go up to 13.5% before it starts to come down.

With the rising inflation an interest rate hike of 25 basis points is not being ruled out in the
October monetary policy review. Experts feel that the task of striking a balance between rising
inflation and growth had got much tougher for the central bank.

"Prices of essential commodities, which include food grains, pulses, edible oils, vegetables, dairy
products, kerosene, soap and safety matches, have more or less stabilised," a finance ministry
statement said. It said that in the case of the primary articles group, the annual point-to-point
inflation increased to 11.83% as compared to 11.43 % reported last week.

"However, out of 98 articles, 17 articles have shown a decline in prices as compared to August 2,
2008. These included rice, maize, urad and arhar, sunflower, linseed and niger seed, raw rubber,
cotton, potatoes, eggs, dry chillies and eggs. Another 56 articles have shown no increase in
prices," it said.

"Inflation may have peaked. There is some softening in commodity prices. Rice and wheat
production is expected to be good although pulses may see some pressure. A possibility of rate
hike by 25 bps is not ruled out. But, now the task of balancing between inflation and growth will
be tough...," CRISIL principal economist D K Joshi said.
Index of manufactured products, which has the highest weight of 63.75% in WPI, rose by 0.2%
during the week on account of higher prices of some edible oils, textiles items, paper and rubber
items. The index for manufactured food products group rose by 0.1% due to higher prices of
khandsari and rape & mustard oil, which were up by 1% each.

Prices of other edible oils, however, declined. The textiles sector, however, continues to see
rapid increase. Rise in prices of cotton yarn-cones by 8%, polyester staple fibre by 7%, mixed
fabrics and cotton grey cloth & canvas by 6% each, other cotton yarn by 5% fuelled a rise in
index for textiles group, which rose 1.6% in the week under review. Higher prices of PVC fitting
& accessories, which were up by 13%, as also cement contributed to the rise in prices of
manufactured products.

HDFC Bank chief economist Abheek Barua feels the inflation peak may be in sight.

"The rise in inflation was in line with expectation. It may rise further on account of the base
effect and then come down. However, some surprises because of the failure in catching data on
time could play the spoil sport. Further, monetary tightening is not completely ruled out but
when globally central banks are going in for expansionary stance, it would be difficult to go in
for contradictory policy now," he says.