INTERVIEW

Deepak Mehta, Managing Director, DNL, DFPCL

August 6^th 2002, Chemical Weekly

High power costs and poor economies of scale must be addressed if Indian chemical industry is to improve competitiveness.

Mr. Deepak Mehta, Managing Director, Deepak Nitrite Ltd. & Deepak Fertilisers and Petrochemicals Corporation Ltd., manages a wide portfolio of chemicals that range from commodities such as methanol and sodium nitrite, to specialities that go into a range of end-use segments. The fertilisers business, operated under the flagship, Deepak Fertilisers and Petrochemicals Ltd., is also trying to strategise growth in an environment not very conducive to its development. While it is grappling with the challenges offered by the lack of clear policy regarding pricing of finished products and feedstock, it is looking to resource-rich countries as offshore production sites to cash in on the availability of cheap feedstock.

There is now a constant endeavour to re-examine existing business and look at new opportunities. While DNL, for example, has grow both organically and through acquisitions, it now is at a critical juncture in its growth, as it looks to international business to augment revenues and profits. The company has identified nice chemistries in which it has acquired expertise and is set to exploit these capabilities to offer a wider slate of products as part of a contract manufacturing service to the global marketplace. DFPCL, on its part, is looking to move up the value-chain in commodities.

DNL is one of the bidders for Hindustan Organic Chemicals (HOC), the state-run chemicals company that operates an integrated chemicals complex at Rasayani and a phenol-acetone complex at Kochi. While a fit with the Rasayani unit of HOC and DNL's product portfolio is prima facie apparent, there are businesses that stick out as oddities and will need closer examination before a decision is taken. DNL is clearly evaluating all of its options, and if it dose decide to go ahead with the acquisition and succeeds in its bid, it will have an opportunity to rationalise its product profile that is now spread across three production sites.

While strategizing these initiatives is the Deepak Mehta's first priority, in this interview with Chemical Weekly that started out as a free-wheeling discussion, he goes beyond the concerns of running his group of companies to discuss a wider range of companies to discuss a wider range of issues that affect the chemical industry. Coming out of the discussions are a range3 of innovative solutions to problems that plague the industry, but have so far defied solutions. Not all of them will work, as Deepak Mehta is the first to concede, but clearly they deserve consideration and close evaluation.

Excerpts from the interview :

Can you dwell on some of the issues that affect the competitiveness of the Indian chemical industry ?

Before reducing duties on chemicals, government should first ensure that duties on fuels and other inputs such as furnace oil, naphtha, etc. are reduced. If one gives priority to reducing duties on feedstock and then reduce the duties on chemicals two years later, then industry will be in a position to compete.

The second major issue is power. The biggest cost disadvantage Indian industry faces today is in energy. Energy is required to add value to any chemical. The point is how one finds a way to get energy at a price comparable to that in other countries around India and provide a level playing field to Indian companies.

Is there any pragmatic way in which we can get over this aspect of high power costs, at least for units who are competing in the global markets?

One major reason cited for high cost of power in India is cross-subsidisation. So we have been trying to develop a model whereby we can first bring in the transparency as to why the cost of power is so high here in India. The cost of generating power anywhere in the world is between Rs. 1.8 to a maximum of Rs.2.2 per KW. If we compare this with the Indian cost of generation, by and large the cost of generation is the same.

So in generation we are not very inefficient. The problem comes about largely because we are giving power to farmers more or less free of charge. Theft of power is also another issue, and I refer to both of these as cost of subsidisation to society.

If this cost of subsidisation to society is the reason why the cost of power to industry is high, then one suggestion is that one breaks up the price at which power is sold into the three components : cost of generation, plus nominal profit, plus the cost of subsidisation. One still ends up paying the same price of power, and all the stakeholders - the State Electricity Boards, the state government and the industry - are in the same situation. The only difference is that the whole exercise brings transparency. If the industry is paying Rs.5 per unit of power, they will know that they are paying some amount, say Rs.2.70, as the cost of subsidisation.

The other thing we have been saying is that whatever power is consumed for exports should be at a special price - one that does not bear the bear the burden of subsidisation to society.

This idea basically germinated from an analysis and understanding of power costs. We have, to some extent, accepted that we in India are not going to get rid of cross-subsidies overnight. The world, unfortunately, does not care about cross-subsidy, so we have to create our own solutions.

We have shared this idea with people in the electricity regularity commission and also with economists. People have liked the idea, but it is still crude and we need to fine-tune it. We need to see how unit consumption and the quantum of exportable product can be linked together, just like consumption of raw material is linked to the quantum of finished product.

We, at ICMA, are planning to have some agency to evaluate this proposal closely, measure the impact on the economy and industry, and the same time also see whether it complies with the rules of the WTO. Only then will we be able to make some sort of a formula or a package.

The chemical industry is the one industry where cost of energy is significant and the diversity in terms of products is large, unlike steel or for that matter any other industry. If we are able to make a model for the chemical industry, then other larger associations could find it acceptable.

The chemical industry there is clearly fragmented. How do we go about correcting this to improve economies of manufacturing?

We realise it is important to bring in economy of scale. We will have to really close down ten small-scale companies and create one large company, so that efficiency of producing increases significantly. We were facing problems of how to tell companies to come together. One model, which could be developed, is where ten entrepreneurs come together and become equity participants of the new company.

How do we fund this process of creation of large-sized capacity?

Two ideas have been brought forward. One is related to the amount of excise duty that we pay. Every industry that adds value generates certain amount of net excise. This amount instead of being paid to government, can be made available to the industry for using it for modernisation. We are short circuiting the entire process of first giving the money to the government, who in turn direct some to the financial institution using for selectively in some industry or the other. The scheme that we have proposed has another advantage - it acts as a self-check as only those companies that are paying large amounts of net excise will be funded by this self-financing mode.

The other issue that we in the industry have been griping with is "Ho can we have tradable tax benefits." `Why Today, if a large company goes ahead and invests, it is not going to pay tax at least for the next ten years, but there is a cash flow that is required today. If you discount this tax benefit that the company is going to get for the next eight years and sell it off right now you can get money to pay for the project cost. There could be buyers, like in the consumer goods industry, who are not making capital investments, but are always on the lookout for tax benefits. They could be attracted to buy these tradable tax benefits from some of our units and pay for our modernisation. We don't then have to go to the government for this.

The government will have to decide between accepting short-term losses for the sake of long term gains. We have scarce resources and will have to find out models that will ensure that these scarce resources are being put to optimum use. In countries like China, the government themselves have been spending huge amount of moneys on infrastructure development, and in general, in supporting industry. Unfortunately, that is not happening here.

In such a system, how do you ensure that funds are not misutilised?

The best solution would be to bring in large amount of computerisation so that data from one source and the other can be merged and harmonised data across the value chain can be worked out. As long as all data gets captured, transparency becomes a part of the game. The introduction of incentives through the Modvat option has also played a role - companies will ensure transparency, because only then they will be able to get the benefit.

Can you comment on why you have opted to look at picking up a stake in HOC?

With regard to HOC, we have been one of the parties who have expressed interest in the disinvestment process. We see some strengths. We also see some weaknesses. For the moment, it would be best to wait for a few more weeks and then share information on this.

On a more general note, I feel that disinvestment is good. It pushes companies to find ways of becoming more competitive. As long as it ensures the entry of reasonably good competition, it is good for the industry, as well.

Do you visualise a rationalisation of your production sites in the event that HOC comes into your fold?

Irrespective of HOC, we have been seriously looking at rationalising our products from a logistics point of view. And it is not just us. Even multinational companies are now looking at keeping fewer sites and investing much more in HR needs and requirements in those sites, rather than trying to operate from more sites.

Today economies and logistics play a far major role than ever before, not just in our company, but in the industry as a whole. All of us are trying to see how to rationalise products, and how to reduce material handling costs.

Is there are a plan to move up the value chain and distance your business from commodities?

Commodities and specialities are two different worlds. I wouldn't say there is anything wrong with commodities. They have their own cycles. As long as you have a position, chances are you can play along with the rest of the world and go through the cycles efficiency. This is a mark of how good you are in terms of competing as a global player.

As far as specialities are concerned, we are able to make high value-added products. In commodities you have a far greater number of players, so the risk is distributed and the market impact is reduced. Specialities have this disadvantage. They are niche markets and as long as they are sustainable you are in the market.

On the other hand, specialities have the advantage that they do not have cycles of ups and downs.

We constantly strive for value for the customer, on the one hand, and value for the shareholder, on the other, and as long as this is there one can operate both businesses. In the commodity side business plans could involve, say, investing in more and more tankages so you can play the volume game ; on the speciality side one may need to invest in joint ventures or collaborations where there is long term commitments from suppliers or buyers.

Can you comment on the challenges facing the fertilisers business?

Ideally, the cheapest source of making fertilisers is gas. However, India today doesn't have enough gas and more than 30% of fertilisers are being produced from naphtha or other liquid fuels. Today naphtha is five times costlier than gas. At the same time, Indian cost of gas is also two and half times costlier as compared to the gas available in the Middle East.

The fertiliser industry is very important to the country's economy. India, China and America are three of the world's largest fertiliser users. So India cannot take a position of a large fertiliser importer, lest it be taken advantage of by international cartels that can make fertilisers so costly that framers cannot afford it.

So, ideally, the solution lies in some way the Indian government encourages setting up of fertiliser plants abroad and bring in fertilisers into India at rates that are competitive for the industry abroad and the country as a whole. But this requires long term commitments of a stable policy.

What would be the impact on employment?

Financially speaking, even if employment is continued and the cost of the employment is borne by the government, it is still far cheaper to get fertilisers from outside. Government subsidies can be brought down drastically. All of this requires long term planning which the government is not willing to apply itself to.

As far as a fertiliser policy is concerned, we are going from one plan to the other, one year to another, and not making any long term planning.

Do you think such a strategy of using the Middle East as a resource base can be extended to chemicals?

In gas based or petro based products - like benzene or toluene - we need to ask whether we should invest our money into making the same products or into making the same products or into making downstream products with tie-ups with the Middle East.

Let them (Middle East producers) feel that their products are being converted into downstream products in India and exported. We are not talking about making profits at the basic and intermediate stage, but, instead, looking at an extended integrated output. I believe, from a commodities point of view, with arrangements with the Middle East, India would be a force to reckon with.

First of all, we need to understand that this is in the long-term interest of India. Secondly, it will be useful to go out and sell (this idea) to the Middle East. Today, the region is being used by the developed countries of setting up large independent plants. But, if India can play its card well, it can sell the proximity of its large market for value added products.

Comparatively, China and America are far more business-oriented countries and if India really wants to be in the lead, politically there should be a greater business orientation.

How do you visualise competing with China?

India can have its own way of competing with China. Sometimes it is best to find ones own solution, rather than copy of the American or German solution. When we are talking of our infrastructure weakness, why are we not able to convince countries in the Middle East and some other countries that are looking at India as a market, to invest in our infrastructure? We can then use the same infrastructure for exporting value added products.

We need to be far more aggressive to play a role in the world, rather than just in India. We have some very interesting role models in companies like Ranbaxy, Dr.Reddy's, Gharda Chemicals, etc., but we need to see is if these success stories can be multiplied in larger numbers.

At the level of your company what is the strategy you have outlined?

Our focus has been to look at growth using the export model. We are not looking at making specialities for the Indian market. Whenever we are looking for export opportunities in Europe and the US, we are talking about customer who are going to be choosy, who are going to demand the best out of us and where we will be placed on equal footing with some of the best players in the world.

Secondly, their sustainability in terms of the market is greater. They are, in a sense, able to give us a reasonable period of stability in prices and the commitment of quantity.

Do you visualise the need for international equity participation to boost exports?

What we have been examining is how stable and sound the business with our foreign collaborator is. If I am making a product where my international partner is also just growing with the product, I would be concerned and therefore more willing if they join me as an major stake of a market that already exists then what I need is clients to purchase the same from me, and not equity participation. So depending on the product, one could decide whether equity is the best arrangement or whether a purchase agreement is good enough. We focus on capitalising on our process strengths and then try to see a business opportunity.

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