‘Lehman II’ Sparks Concerns, Indian Chemical Industry Stands Firm as Global Giants Struggle

Global chemical giants are grappling with a significant decline in sales, with some even dubbing it the “Lehman II” episode.
However, their Indian counterparts appear less perturbed by this downward spiral, expressing confidence in the resilience of the domestic industry against potential blows.

The chemical sector’s current crisis, reminiscent of the collapse of Lehman Brothers during the global financial crisis and the resulting chain reaction, is rooted in an event termed as an “inventory recession” or the “Great Destocking.”

The disruptions in supply caused by the pandemic prompted manufacturers to stockpile chemicals as a precautionary measure. The anticipation was that these reserve stocks would be rapidly depleted once the economy regained momentum.

Yet, global economic rejuvenation has remained sluggish, or even nonexistent in some cases. This trend, analysts suggest, is driven by a confluence of factors including geopolitical tensions, inflation, sustainability concerns, disruptions in supply chains, and demographic shifts.

The crux of the concern lies in the fact that chemicals are the essential building blocks and raw materials for a wide range of products. While the industry’s significance in the modern economy might not always be evident, chemicals find application in various domains such as food, packaging, clothing, electronics, pharmaceuticals, fertilizers, transportation, and advanced research.

Sluggishness Ahead “Lehman II”

An Oxford Economics report commissioned by the International Council of Chemical Associations (ICCA) indicates that in 2017, the industry contributed approximately $5.7 trillion to the global GDP, equivalent to around 7%—roughly the combined economic output of India, Brazil, and Mexico.

The report emphasizes that this places the chemical sector as the fifth-largest manufacturing sector worldwide, constituting 8.3% of the total economic value of global manufacturing.

The concerns were exacerbated when the CEO of Lanxess AG, a German speciality chemical manufacturer, Matthias Zachert, likened the persistently weak demand and destocking across various industry markets to a “Lehman II” scenario.

This comment, made in late June, garnered global attention, particularly due to the series of profit warnings issued by numerous major chemical companies. Although these remarks were delivered in June, experts point out that the diminished demand for fundamental raw materials indicates a potential slowdown in economic activity, thereby extending the ripple effects.

Impact In India
The impact of destocking is also being felt within India. According to Abhay V Udeshi, Chairman of Chemexcil—an apex industry body responsible for promoting chemical exports—chemical firms worldwide are reporting a grim business situation.

Additionally, energy cost pressures are affecting the European Union’s industries, making operations challenging. Furthermore, Chinese chemical companies are offloading their inventories at extremely low prices, leading to heightened price volatility and uncertainty.
Udeshi predicts that this challenging phase could persist for another two quarters, with domestic players expecting a 10-30% reduction in sales this quarter compared to the corresponding period last year.

Given the interconnectedness of the sector with global value chains, any slowdown in consuming industries will have implications for domestic chemical firms, regardless of their scale.

India Still Fares Better Compared To Its Global Counterparts
Amidst these concerns, Siddartha Cherukuri, Joint Managing Director of Vishnu Chemicals based in Hyderabad, believes that although the industry is experiencing pressure due to over a 10% sequential drop in commodity prices, not all players are equally affected.

Cherukuri highlights that companies with value-added products, versatile production lines, backward integration, and adaptable product mixes are better positioned to navigate challenges and mitigate cyclicality and geographic risks.

India’s chemical industry, valued at $220 billion, boasts extensive diversification, encompassing over 80,000 commercial products. It contributes around 7% to the nation’s GDP and employs over 2 million individuals.

The country ranks as the sixth-largest chemical producer and the eleventh-largest chemical exporter (excluding pharmaceuticals). Projections suggest the industry will expand by 9.3%, reaching $304 billion by 2025.

Micro, Small, and Medium Enterprises (MSMEs), particularly smaller entities, play a pivotal role in driving growth within this sector. Based on the share of MSMEs in the manufacturing domain, ICRA estimates that small and medium-sized enterprises constitute 25-30% of the chemical sector.

While a significant portion of MSMEs operate within the informal sector, it’s challenging to quantify their exact share in the chemical segments. However, ICRA estimates their presence at 45-50% in agrochemicals, 60-65% in dyes and pigments, and 50-75% in other speciality chemicals.

This fragmentation holds strategic importance within the chemical manufacturing industry value chain, contributing to low value-added product manufacturing, subcontracting for more prominent domestic players in downstream sectors, and performing tasks like purification and blending.

The Positive
Despite the prevailing global crisis, pockets of optimism persist. Rakesh Surana, a Partner at Deloitte India, notes that while the global turmoil hasn’t dampened demand for all types of chemical products, certain industry players remain confident in the sector’s resilience amidst the global economic downturn.
While chemical shipments to the European Union have been affected, the U.S. market maintains its strength.

India’s chemical exports reach 175 countries, with key destinations including China, the USA, Brazil, the Netherlands, Saudi Arabia, Indonesia, the UAE, Japan, and Germany.

Export data from Chemexcil for 2021-22 highlights a rise in exports to the top 25 countries. For instance, exports to the U.S. surged by 59% in 2020-21, where the U.S. consumes 17.73% of India’s chemical exports, followed by China at 12.7%, Brazil at 8.52%, Saudi Arabia at 6.12%, and the Netherlands at 5.23%.

Nevertheless, India’s production of basic major chemicals and petrochemicals witnessed a significant drop, with a decline of 53.73% in FY23 compared to the previous year. Exports of major chemicals and petrochemical products experienced an even more drastic decline, plummeting by 64.67% year-on-year to $8.6 billion.

Parag Jhaveri, MD of Yasho Industries, disagrees with the comparison to the Lehman crisis, considering the sturdy domestic demand and the promising performance of the U.S. market. While he acknowledges that agrochemicals are encountering a slight downturn in sales volumes, he states that there’s substantial demand for various chemical types, including specialty chemicals.

The Indian chemical industry encompasses bulk chemicals, agrochemicals, specialty chemicals, polymers, petrochemicals, and fertilizers.

The composition of major chemical segments in India is as follows: basic major chemicals (21%), basic petrochemicals (34%), and other petroleum products and intermediates (45%).

The country ranks fourth in agrochemical production and accounts for 50% of technical-grade pesticides. It stands as the third-largest polymer consumer and is a significant dye supplier, responsible for around 16% of global dyestuff and dye intermediate production.

Experts contend that India’s chemical sector presents multiple growth opportunities that seem relatively insulated from current threats. Foremost, McKinsey predicts that India will contribute over a fifth of incremental global chemical consumption over the next two decades, driven by an estimated rise in domestic demand to $1,000 billion by 2040.

This demand surge spans diverse sectors such as agriculture, consumer goods, infrastructure, automotive, electronics, and healthcare. Additionally, the domestic industry isn’t heavily reliant on overseas markets for raw materials. A sizeable proportion of India’s chemical output—approximately 33%—is consumed by domestic companies.

Navroz Mahudawala, Founder and Managing Director of investment advisory firm Candle Partners, suggests that the geographic aspect has cushioned India from the worst effects of the downturn compared to other regions, particularly Europe.

While acknowledging the likelihood of a single-digit to early double-digit decline in chemical sales based on geographical focus, Mahudawala highlights the greater resilience of the domestic industry due to its low leverage levels (debt-equity ratio).

Larger industry players, having previously invested aggressively based on past cash flows, are better equipped to handle increased demand when it arises. A positive development comes in the form of a Production Linked Incentive (PLI) Scheme tailored for the chemicals industry.

Deloitte’s Surana suggests that the government might extend the PLI scheme to chemicals and petrochemicals, stimulating further investment. He views this as part of India’s transformation into a manufacturing powerhouse, presenting itself as a compelling alternative manufacturing hub to China. Such a scheme for basic chemicals would enhance self-reliance and resilience, facilitating the industry’s growth.

Even during the global financial crisis, India demonstrated a degree of insulation from direct shocks due to minimal exposure to subprime lending and limited ties to the U.S. markets.
Similarly, experts predict that while domestic chemical companies may initially fend off direct impacts, those that fail to adapt to evolving market dynamics and reassess their supply chains might eventually experience adverse consequences.

The Last Bit, As the global chemical industry navigates the challenges of a major downturn, the Indian chemical sector emerges as a beacon of resilience.

Its diversified product portfolio, domestic demand, geographic insulation, and government initiatives like the PLI scheme collectively form a robust defence against the headwinds of economic uncertainty.

This unique blend of factors positions the Indian chemical industry to not only withstand the ongoing crisis but also to thrive and contribute significantly to the nation’s economic growth in the years ahead.