Lagging Behind

In order to analyse the competitiveness of the Indian petrochemicals industry in the global markets, it is necessary to look at the comparative manufacturing economics of petrochemicals products in India and in other countries across the globe.

From the accompanying tables on the comparative costs of manufacturing plastic and synthetic fibres, it is clear that the production cost of plastic commodities and synthetic fibre is highest in India compared to countries like Korea, China, Thailand and Malaysia. A higher production cost is the biggest deterrent to the way to the global markets. This high production cost can be attributed to factors like an increased raw material cost, high rate of interest, high energy costs, obsolete technology, resulting in low efficiency and productivity, small plant size and high capital costs, resulting in a high depreciation and interest burden.

Another factor for the reduced competency of the Indian petrochemical industry in the global market is the higher cost of petrochemical plants in India compared to other countries. As the accompanying table shows, the capital cost of a plant in India is about 39 per cent more compared to the international market.

The main components causing the increase in the capital cost are imported equipment, technical know-how and pre-operating expenditure. The factors that give rise to this high capital cost are a long gestation period (the interest during the construction period is capitalised and the pre-operating expenditure goes up), high financing charge (which increases the cost of the capital), infrastructure limitations (increases the transportation and construction costs) and a high import duty on capital goods (increases the cost of imported equipment)

So both the high production and capital costs handicap Indian petrochemical plants. In order to overcome these barriers and become competitive in the international market, we need to take action at all levels. The country needs to focus on the upgradation of technology, changes in government policies and the development of infrastructure.

In a globally competitive market, technology plays a major role in maintaining the quality of the products, efficiency of operations and productivity of the industry. Hence access to state-of-the-art technology is a must to remain competitive in the global market. Simultaneously, India has a wide base of technical talent which needs to be effectively utilised. To ensure proper utilisation of technology and talent, the following steps must be taken:

The petrochemical industry was initially set up to cater to the small demand within the country. At the same time, it enjoyed the protective environment provided by the government with a high import duty on products. As a result, the industry was inefficient and the cost of production was very high. Now, with the opening up of the economy, the industry should put up petrochemicals complexes with capacities that are over the minimum economic size and are equal or nearer the global size.

Second, in view of the uncertainty in the availability of feedstock and its volatile price as well, petrochemical plants should be designed to crack feedstock with a wide variation in composition. To increase the efficiency of such crackers, advance control systems with on-line optimisers should be provided. The optimiser can take the feedstock composition, feedstock price and prices of different final products as inputs and set the operating parameters at the optimum level.

Petrochemical complexes typically generate lots of by-products, which can be utilised in refineries to blend with some of their products. At present, these streams are used as fuel in the petrochemicals complexes. However, more value addition is possible by further processing these streams together with refinery products. So the possibility of integrating petrochemical plants with refineries needs to be encouraged for better utilisation of petrochemical products.

This is a hi-tech industry. An integrated control system requires a high level of automation. It is essential for functions like process control, accounting and production management, marketing and purchase to be seamlessly integrated on a common business application platform such as Enterprise Resource Planning (ERP). The objective behind such automation is not to reduce manpower requirement, which is anyway low. But it is an essential ingredient of efficiency which is a pre-requisite for sustaining growth in a competitive environment.

The industry should also pledge itself to enhance research and development (R&D) expenditure to at least 1.5 to two per cent of sales by the turn of the century. This indicates expenditure within the firm as well as outside it. The government must also provide income tax incentive for in-house R&D and R&D expenditure made by the firms in universities, laboratories and other institutions.

In fact, petrochemicals companies must come together to form a consortium fund for R&D relevant to the industry. The funds and the development programme can be managed by an independent organisation constituted by the industry. This organisation should evolve a mechanism to identify the latest developments in the industry across the globe and make it available to the Indian industry with a minimum cost implication.

Besides, each company should adopt academic and training institutes such as the Indian Institute of Technology and regional engineering colleges, which have programmes of relevance. Interaction between the industry and these academic institutions should be encouraged.

At present, most of the research institutes in India work in isolation and this research work is hardly commercialised by the industry. As a result, most of the research work remains on paper and is used only for academic purposes. The real benefit of the research does not reach the market place. The research institutes should orient themselves to market needs. Research institutes should let the industry pay for and use the expensive and specialised equipment which is available and under-utilised by the institute.

Further, Indian engineering services in plant design, process engineering and plant construction have become extremely competitive. Engineering consultancy firms should explore the possibility of forming strategic alliances with foreign consultancy firms. The government must allow the public sector engineering companies to enter such international alliances on a priority basis.

To stay globally competitive, one-time investment is not sufficient. Upgrading product quality and increasing productivity by continuous modernisation is a must. The government should provide fiscal incentives for modernisation and must bring down import duties for spares and replacement equipment.

On the government policy front, given the fact that the petrochemicals industry is highly capital-intensive, government policies, finance management and taxation structures should be correctly aligned to attract large investments in India. The following areas need to be addressed:

Import duties

Historically, import duty rates are kept at a high level to protect indigenous industries against low-priced imports, to raise revenue and to discourage imports in order to conserve foreign exchange. In such a structure, the capital cost of a project becomes very high because of the high import duty on capital goods. This leads to a higher interest burden as well as high depreciation cost. Also, import duties on raw materials makes for a higher cost of production. The government has already taken action to reduce this import duty burden and this liberalisation should continue. The tariff structure should be as follows:

The import duties for basic feedstock and building blocks should be nil, for intermediates, it should be 60 to 80 per cent of peak duty and for end products, it should be the peak duty.

Then, import duties on capital goods and spares must be reduced to a minimum. Import duties on catalysts should also be similar to that on capital goods especially because, by and large, there are no domestic catalyst manufacturers to protect. The tax on technology imports continues to be 30 per cent, from the pre-liberalisation era. This must be brought down to zero in order to encourage use of state-of-the-art technology.

Easy clearance

Licensing and clearance procedures to obtain approval for a petrochemicals industry are quite lengthy and cumbersome. This is responsible for long gestation periods and thereby increases the pre-operating expense and capital cost of the project. Since technology is also changing constantly, a long gestation period results in the use of technology that becomes obsolete by the time the plant starts commercial production.

Considerable delays also occurs due to the existence of various statutory control organisations such as boiler inspectors, electrical inspectors, factory inspectors and the like. The large number of clearances which have to be obtained from the state governments also adds to the delay in project implementation.

In order to bring down the gestation period to international levels, while ensuring adequate safety measures, the government should implement a single-window concept for obtaining all relevant approvals for setting up and thereafter for operating petrochemicals plants.

Capital costs

Petrochemical plants are highly capital intensive. The high cost of capital increases the operating costs of the plants. The current rate of interest on term loans is around 17 per cent, much higher than that in Taiwan, Korea, Malaysia and Indonesia. In general, if the cost of capital is three per cent more than inflation, it will be very difficult to remain competitive.

Some of the steps that could be taken to make finance available at globally competitive interest rates include reducing the cost of funding large investment within three per cent over inflation, relaxing SEBI restrictions on promoter shareholding requirements and providing an extended line of credit for 14 to 15 years so as to enable the industry to take care of the cyclical nature of the business.

Improved infrastructure

All Indian industries require an efficient infrastructure. Transportation of goods and power are particularly important for a healthy petrochemicals industry.

Pipelines have been established as the ideal form of transporting liquid and gaseous petrochemicals. To encourage this mode of transportation, the government should earmark pipeline corridors or grids. The pipelines should be well connected to the ports so that the movement of goods both at the port and on shore are streamlined.

An efficient movement of goods across the border will be essential for the survival of any player in the global market The country's geographical structure requires such a movement to be only through ports. Around three to four shore terminals should be put up to import basic building blocks like naphtha, ethylene, propylene and butadiene. The terminals should have a network of pipelines, which would be feed a number of downstream units for production of value-added products. Meanwhile, the optimum use of existing port facilities within refineries will provide much-needed help to the industry.

The industry does not demand excessive amounts of electric power. The cost of power delivered is high due to unreliable supply. Loss of production due to sudden power failures and wastage of raw materials and fuel also adds to the cost. So steps should be taken to encourage plants to set up co-generation units. Meanwhile, the quality of power supplied by the state electricity boards should be improved substantially.

The issues identified in this paper and the remedial factors suggested are indicative, and should form the basis of a discussion to arrive at firm initiatives.

Excerpted from a Background Paper prepared by Prabhakar Sethi, executive vice-president, Haldia Petrochemicals Ltd, for a seminar on 'Growth Potentials in the Indian Petrochemicals Industry' organised by the Federation of Indian Chambers of Commerce and Industry.