Post China+1, specialty chemicals segment in India to gain disproportionately

The Indian chemical industry is at the cusp of a structural growth, led by the shift in global supply from China, increase in outsourcing opportunities due to global consolidation and domestic demand, fuelled by burgeoning consumption.

While all players in the chemical industry in India would benefit from this shift, specialty chemical manufacturers will gain the most, given the higher entry barriers and potential for value-added niche products.

China’s journey downhill

Over the last three decades, China has emerged as the most dominant player in the $4-trillion global chemicals industry, with nearly 36 percent market share. Lower labour costs, high subsidies (capital and export), and, more importantly, relaxed environmental norms were among the key factors that led to this unparalleled success. However, many of these factors have proven to be unsustainable in the long run.

Apart from rising labour costs, stricter implementation of pollution-control measures and withdrawal of subsidies have eroded China's cost advantage. Relocation of toxic manufacturing plants to dedicated industrial parks, along with higher operational and capital costs, have hit the operations of Chinese chemical companies, resulting in large supply-chain disruptions in the industry.

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Manoj Garg

Director- Investments|White Oak Capital Management

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This has led to global chemical companies seeking to diversify procurement away from China (commonly known as 'China+1' strategy). While large chemical plants may shift to dedicated zones, we believe that the implementation of the above-mentioned policies by China will result in an adverse cost structure, compared to other alternatives like India.

Apart from reducing export incentives, the Chinese government's introduction of a green tax, based on the quantity of solid waste produced in the manufacturing process, will significantly reduce the profitability of Chinese manufacturers and discourage new entrants.

Enter India

India is emerging as a structural beneficiary of the 'China +1' diversification model. Beyond the labour cost advantages, a large pool of technically qualified manpower, strict adherence to global manufacturing standards and strong protection of intellectual property (IP) rights have led to rapid scaling up of the chemical industry in India.

Having proven its worth in the pharmaceutical industry as the 'Generic capital of the world', Indian chemical manufacturers are well poised to emerge as a credible alternative, and, in some cases, primary suppliers to global firms. Early signs of this trend are already visible as Indian manufacturers are embarking on large capacity additions, including dedicated contract manufacturing facilities.

The specialty chemicals edge

Within the overall chemicals industry, specialty chemicals will benefit disproportionately owing to high entry barriers and differentiated offerings. Many Indian companies have been investing in research and development (R&D), which is enabling them to move up the value chain and create multiple growth opportunities.

Additionally, the government's thrust towards 'Make in India' in sectors like pharma, automobiles, advanced chemistry cell, textiles and food processing will help in expanding the domestic end-user market size, enabling manufacturers to derive benefits from economies of scale.

India's chemical industry has grown by 12 percent over the last five years and even a 1-2 percent incremental market share gain from China can result in high-teens growth rates here on. Growth will be underpinned by stable regulations and active enforcement which would provide a long runway of sustainable growth for the industry.

While the growth prospects look promising, the sector has high sensitivity to ESG (environmental, social and corporate governance) factors and as the industry in India evolves, the government will have to play a key role in striking a fine balance between industrial growth and environmental sustainability.

We believe companies with a strong track record of execution, R&D capabilities, sustainable manufacturing practices, and presence in sustainable chemistries will be long-term beneficiaries of this underlying trend.

The writer is Director, Investments, White Oak Capital Management
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