Indian drug makers see hike in Chinese raw material as an opportunity to produce locally

Laurus Labs isn’t an isolated case. Even large Indian drug makers like Cipla, Lupin and Aurobindo Pharma are feeling the heat of rising Chinese raw material prices as the world’s second-largest economy shuts down thousands of factories in an unprecedented crack down to check pollution and raise overall safety standards.

Media reports estimate 40 percent of all China factories have been shut down in the last one year at some point in order to be inspected by environmental bureau officials resulting in late and missed orders and increased costs.

In addition to stringent environment and safety expectations, the rising cost of manpower in China and higher crude oil prices are also pushing the prices north.

Meeting India's needs

There are around 7,000 active pharmaceutical ingredient manufacturers in China, catering around 80 percent of India drug makers’ raw material needs.

According to government, India's import of active pharmaceutical ingredients (API) from China stood at Rs 12,254.97 crore in 2016-17.

Chinese companies over the years have built huge capacities with support from their government through cheap loans, better infrastructure and not so stringent environment and safety regulation, though the difference in labour cost between India and China is only 3 percent.

Blessing in disguise

But things would be different this time, says Satyanarayana Chava, CEO of Laurus Labs, hinting that the price hikes of Chinese raw materials may be irreversible.

Chava says Laurus, which was importing 100 percent of some of its key raw materials from China in Q1, plans to produce them entirely in-house by end of Q3.

Currently, it has brought down the dependence to half.

Chava says Indian companies all these years were trying to capture the upper-end of the value chain, ignoring the raw materials. But the steep price rise may force them to take a re-look.

“We are not going to have our cost of production higher than our purchase. If we backward integrate, the availability of raw material will be more certain and we will save the money so that our gross margins will grow up,” Chava said.

He added his company hasn’t added any additional capex to produce raw materials, it eased bottlenecks  ofat some its existing lines and then started manufacturing.

“In short term there will be pain for Indian pharmaceutical industry, but in long term it’s a great opportunity,” Chava said.

India’s fourth-largest drug maker Cipla is also examining possibility of making certain intermediates in-house and increasing local sourcing to mitigate the Chinese price hikes.

Cipla took a hit of 40 basis on its sales in Q1FY19 due to rising raw material costs. Cipla had sales of Rs 3,939 crore in the first quarter.

“In terms of indigenization, at least of intermediates could examine some of those plans, but those are capital-intensive plans, so in terms of short-to-medium-term probably nothing much,” said Kedar Upadhye, Global CFO of Cipla.

“In case of local sourcing, some of the opportunities could emerge,” Upadhye said.

India's second-largest drug maker Aurobindo Pharma says it has started procuring from Indian sources.

“I think wherever we see that it is (prices) going beyond the threshold, we've already started qualifying Indian sources,” said N Govindarajan, MD of Aurobindo Pharma.

“I think, this is something. In fact, at one level I would even say, this is beneficial because otherwise, we would not have looked at all these options of securing ourselves,” Govindarajan added.

Policy action

To be sure, the government is also concerned about India’s over-reliance on Chinese raw materials. For instance, for critical antibiotics like penicillin, India relies mostly on China putting the drug security at stake in cases of a war or major outbreak of infectious disease.

In the Draft Pharmaceutical Policy – 2017, the government talks about encouraging end-to-end indigenous drug manufacturing including that of APIs and intermediates with proposals such as giving preference in government procurement and also exempting the formulations from drug price controls for five years if they have indigenous content.

The draft policy also says all APIs which can be indigenously manufactured should be imported at peak customs duty.

The other proposal is to setup mega bulk drug parks with common facilities for pollution control and effluent treatment under public-private partnership mode.

The draft policy is yet to be implemented. Much of those proposals have been gathering dust for some time.

One top pharma executive on condition of anonymity blamed the government for flight of API and intermediate manufacturing to China.

The governments earlier were indiscriminately capping the prices of APIs and Intermediates used in drug manufacturing, forcing formulators to look for cheapest raw material elsewhere to save margins, forcing many companies to shutdown or cease manufacturing, the executive says.