Identifier
Created
Classification
Origin
08MUMBAI46
2008-02-11 11:12:00
UNCLASSIFIED
Consulate Mumbai
Cable title:  

INDIAN IT AND TEXTILE INDUSTRIES STRUGGLE TO COPE WITH

Tags:  ECON EIND ETRD IN 
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UNCLAS SECTION 01 OF 05 MUMBAI 000046 

SIPDIS

SIPDIS

DEPT PASS TO COMMERCE FOR ART STERN

E.O. 12958: N/A
TAGS: ECON EIND ETRD IN
SUBJECT: INDIAN IT AND TEXTILE INDUSTRIES STRUGGLE TO COPE WITH
MATURING BUSINESS MODELS AND A RISING RUPEE

MUMBAI 00000046 001.2 OF 005


UNCLAS SECTION 01 OF 05 MUMBAI 000046

SIPDIS

SIPDIS

DEPT PASS TO COMMERCE FOR ART STERN

E.O. 12958: N/A
TAGS: ECON EIND ETRD IN
SUBJECT: INDIAN IT AND TEXTILE INDUSTRIES STRUGGLE TO COPE WITH
MATURING BUSINESS MODELS AND A RISING RUPEE

MUMBAI 00000046 001.2 OF 005



1. (U) This cable is classified as sensitive but unclassified.
Please treat accordingly.

2. (U) Summary: India's two largest foreign exchange earners -
the textile and IT industries -- are struggling to adjust to the
appreciation of the Indian rupee against the dollar. However,
in a series of discussions with interlocutors from the IT and
textile industries, Congenoffs learned that the rising rupee is
just one of many problems faced by the two industries. The
software industry's trade association, NASSCOM, said
expectations of a slowing U. S. economy and a human resource
crunch resulting from the booming domestic economy are equally
responsible for the industry's current challenges. A
representative from the textile industry also noted that the
expectation of a slowdown in the U. S., coupled with the
expiration of the multi-fiber agreement, have also hit the
industry. Both industries are trying to cut costs and are
looking to new export markets for revenue. While the IT
industry has been trying to lobby the Government of India to
preserve tax breaks on exports, the textile industry has been
trying to obtain similar tax breaks. Irrespective of whether
they are successful, both industries feel the imperative to
develop innovative strategies and re-tool business models to
stay afloat and weather the current crisis. End Summary.

IT and Textile Industries Among Biggest Export Earners
-------------- ---

3. (U) The information technology (IT) and textile industries
are important export industries and foreign exchange earners for
the Indian economy. In 2007, the IT industry's revenues touched
USD 39.6 billion of which USD 31.4 billion were exports. At the
end of 2007, the industry directly employed 1.6 million people
and accounted for 5.4 percent of India's GDP. After years of
fast growth, the IT industry is well-represented with the top 20
IT companies, who generate 80 percent of export revenues of the
industry. The industry is projected to grow 12-15 percent in
2008 after years of 30 percent plus annual growth. Estimated to
employ 2.5 million people, the textile industry is one of

India's oldest industries. The textile industry's export
revenue stood at USD 20 billion and accounted for one-sixth of
India's total export revenue in 2006 according to DGCIS
(Directorate General of Commercial Intelligence & Services)
data. The textile industry is very fragmented, with almost 300
exporters earning revenues over USD 25 million.

Twin Impact of Rising Rupee and Slowing U.S. Economy Too Much
Too Fast
-------------- --------------

4. (U) Rajiv Vaishnav, Regional Director of the National
Association of Software & Service Companies (NASSCOM),told
Congenoffs that the profitability of the Indian IT industry has
recently taken a double hit: first, by the speed of the rupee
appreciation via-a-vis the dollar, and second, by the slowdown
in the U.S. economy. The Indian IT industry has primarily been
export driven with the domestic IT industry accounting for only
around 20 percent of the total industry revenues, Vaishnav
explained; of these exports, the U.S. market accounts for over
50 percent. The slowdown of the U. S. economy has therefore
dampened future growth prospects for the industry, although he
admitted that the immediate fallout is lower profit margins,
rather than decreased growth. In a separate discussion, Atul
Nishar, the chairman of Hexaware Technologies, confirmed this
trend. He reported that while his company's profit margins had
been impacted, sales growth largely remained intact despite the
company's dependence (more than 50 percent of sales) on the U.S.
market.

5. (U) In a separate discussion, Rahul Mehta, the President of
the Clothing Manufacturers Association of India (CMAI),pointed
out that the speed at which the rupee appreciated (12 percent
since January 2007, with a rise of almost 10 percent since April
2007) caught textile exporters off-guard. If the rise had been
spread over a longer period of time, he said, then exporters
could have adjusted the pricing of contracts with their
suppliers and customers. He stated that the impact of the
stronger rupee via-a-vis the dollars was even more severe, as
70-80 percent of the textile industry's export revenues are
dollar denominated. The U.S. accounts for 30-35 percent of the

MUMBAI 00000046 002.2 OF 005


industry's export market. All exports to Middle Eastern markets
and 70 percent of European sales are also priced in dollars, he
explained. Manojj Kumar Patodia of Prime Textiles, a major
textiles manufacturing firm with mills in Tirupur in Tamil Nadu,
confirmed that many of his company's European contracts were
priced in U.S. dollars, and he was looking to switch to Euro
pricing. Mehta also pointed out that the industry had an import
content of just 3-5 percent, and therefore had little scope to
offset the impact of the stronger rupee. He admitted that
India's lowering of import tariffs for imported fabrics to meet
its WTO commitments would increase the percentage of imported
fabric content in textile exports.

6. (U) Moreover, Mehta continued, along with the weakening of
the dollar, the slowdown in the U.S. economy has resulted in
fewer orders and reduced margins. The industry had been able to
handle this scenario in the past because the multi-fiber
agreement had ensured that Indian suppliers had access to some
portion of the U.S. textile market. But with its expiry, Indian
manufacturers now have to compete with cheaper Chinese
manufacturers and Southeast Asian manufacturers, he explained.
Margins are therefore very slim for textile exports. He
claimed that the average margin for a textile exporter is just
8-9 percent, so a 10-11 percent appreciation in the rupee has
wiped out margins. As a result, several exporters are currently
running their business at a loss and hope to ride out the
crisis, he continued.

7. (U) In contrast to CMAI Mehta's claims, Patodia of Prime
Textiles informed Econoff that, surprisingly, his business had
started to turn around in the last month. Whereas he had
partially retooled his business towards the domestic economy, he
was also discovering that international buyers did not want to
be solely reliant on China for their purchases and were willing
to continue supplier relationships with Indian firms, despite
their higher pricing, to diversify. Indian firms are reliable
suppliers of high quality goods, which Patodia claimed many of
his other South Asian competitors cannot promise. Tax sops or
no tax sops, Patodia, for one, was optimistic about the business
outlook for the rest of the year.

IT & Textile Industry Both Lobby for Tax Breaks to Soften the
Rupee Rise
-------------- --------------

8. (U) Vaishnav informed Congenoffs that NASSCOM is lobbying
the Indian government to preserve tax exemption on export
earnings for IT industries under the Software Technology Parks
of India (STPI) scheme. (Note: The government created the STPI
scheme to encourage and enhance software exports from India by
setting up dedicated software technology parks with good
infrastructure, technology, and professional training services.
The STPI is aimed at facilitating the software export industry
and especially the SME (small and medium enterprise) segment to
maintain a competitive edge in the global market. End Note.)
Units in the STPI were given a 10-year tax holiday, which ends
in March 2009. NASSCOM wants this extended for another 10
years. Congenoff pointed out that the Indian IT sector's pleas
for continued tax breaks and other government sops to ensure its
survival contrasted with the projection of its image
internationally, in which industry representatives routinely
boasts about its world class products and competitive pricing.

9. (U) Vaishnav maintained that these exemptions were critical
for the SME segment of the Indian IT sector, which he claims is
most severely affected by the rising rupee. While the larger IT
companies have the financial resources and the knowledge to
hedge against currency appreciation, small and medium IT
companies do not, Vaishnav said. He claims that the withdrawal
of tax sops under STPI will hit the SME segment
disproportionately hard. Large IT companies can always move
their operations to Special Economic Zones (SEZs) and thereby
preserve these tax breaks. But smaller companies do not have
this option because of the high rental cost at the SEZs,
Vaishnav explained. NASSCOM has been lobbying the Indian
central government to preserve these tax breaks for the last two
years and Vaishnav believes that there is a 60 percent chance of
success. Atul Nishar, the Chairman of Hexaware Technologies and
the former Chairman of NASSCOM, was even more optimistic and
expects tax relief in the coming budget. He pointed out that

MUMBAI 00000046 003.2 OF 005


the government will be seen as favoring large corporates and
ignoring the SME sector if it removes tax benefits in STPIs but
keeps these incentives in SEZs.

10. (U) CMAI's Mehta separately told us that like the IT
industry, the SEZ model was not feasible for the textile
industry which also primarily consists of small- and
medium-sized players. The barriers between the domestic and
export industry are breaking down in the textile sector, he
noted. Textile exporters also sell their goods to the domestic
market and while not prohibited, domestic sale from a company in
an SEZ is an administrative inconvenience, he added.

11. (U) CMAI, like NASSCOM, is also lobbying the government
for tax concessions. Mehta told us that the industry is
demanding that textile exporters get refunds of state and local
taxes paid in addition to the existing refund of federal tax.
These account for 4-6 percent of the FOB (freight on board)
price of the good, he added. Patodia of Prime Textiles called
state and local taxes the number one impediment to his business.
Mehta of CMAI also said that the industry is lobbying for a
lowering of domestic interest rates of around 9 percent charged
to exporters to the internationally prevailing 3-4 percent. The
textile industry wants more flexible labor laws which permit
temporary and contract employment in the textile industry,
although he privately acknowledged that this is a tall order
given the current political alignment in Delhi. Mehta added the
industry was demanding cheaper and more reliable electricity
supply.

Slowing U.S. Economy Forces Export Diversification
-------------- --------------

12. (U) Vaishnav stated that the IT industry is now looking to
diversify its export revenue base to Europe and Asia -- two
relatively untapped markets -- to cope with the twin impact of a
rising rupee and slowing U.S. economy. Vaishnav noted that the
IT company Datamatics, for example, now obtains most its export
revenue from the U.K. Nishar of Hexaware added that his company
is planning to reduce its exposure to the U.S. market from the
current level of 68 percent to less than 60 percent. Nishar
also believes that while the Indian IT industry will be badly
hit in 2007-08, he expected that a revival of the U.S. economy
in 2009 will lead more U.S. companies offshore to India as they
become even more aware of cost efficiencies. The Indian IT
industry will therefore see an uptrend in business in 2009-10,
he opined. He sees the current business environment as similar
to 2001-2002 when a slowdown in the U.S. initially hit the
Indian IT industry hard but was followed by a sudden upswing in
business as U.S. firms decided to increase off-shoring to
contain costs and build shareholder value.

13. (U) Meanwhile, CMAI's Mehta stated that Indian textile
manufacturers were also looking to diversify into new markets.
He himself led a trade delegation under CMAI to Chile and will
soon take a delegation to China, which Mehta claimed was open to
receiving exports from India because China's industry so dwarfed
India's that it did not feel threatened. Mehta admitted that
the industry had been short-sighted, developing trade relations
with the U.S., Europe and Middle Eastern countries at the
expense of Latin American, Southeast Asian, Eastern European and
East Asian nations. The industry is now looking at these
markets as export destinations and not just as sources of
supply.

Cost-cutting Measures to Stem the Impact
--------------

14. (U) NASSCOM's Vaishnav also told us that the IT industry
is trimming costs to improve eroding bottomlines. The industry
is trying to lower the salary expectations of its employees and
is also cutting down on the "extra" benefits or frills given to
employees. Analysts believe that the IT industry wage bill will
appreciate by only 10-12 percent this year, as compared to an 18
percent rise in wages last year. Tata Consultancy Services, one
of the largest Indian software exporters, shaved off around two
percent of the variable pay linked to the company's performance
from its employees' salary for the January-March quarter.
Equity analysts believe this cut is designed to send a message
to employees that all is not well with the IT sector, so as to
lower their annual salary review expectations. Along with

MUMBAI 00000046 004.2 OF 005


managing wage costs, the industry is looking to expand to
lower-cost Tier 2 and Tier 3 cities (smaller towns and cities);
Vaishnav described this as the motivation behind the recent
establishment of a new office of Datamatics Corporation in
Nashik, Maharashtra, and the plans for Satyam to open an office
in Nagpur. Hexware's Nishar confirmed these cost-cutting
measures and said his company was not only lowering salary
expectations but is also increasing the work day of its
employees from 8 to approximately 9 hours a day. Nishar will
also try to increase the percentage of employees being utilized
at a given time, from the current 70-75 percent. Nishar added
that his company, along with several other larger IT players,
planned to increase billing rates both for renewals and new
contracts to soften the impact of the strengthening rupee.

15. (U) CMAI's Mehta, told us that while large Indian textile
exporters have cut staff to trim costs, some small manufacturers
have simply been forced to shut down. He estimated that as of
November 2007, the industry had lost 75,000 jobs, and he expects
150,000 job losses by March 2008. (Note: Mehta confidentially
admitted that many of these "laid-off" workers were absorbed
into the booming domestic textile industry or went back to the
villages to resume agriculture. End Note).

IT Human Resource Crunch Unlikely Fallout of the Booming Indian
Economy
-------------- --------------

16. (U) Vaishnav noted that the booming domestic economy has
shrunk the large pool of professionals from other industries who
wanted to move into the IT sector. For example, Vaishnav
pointed out that whereas ten years ago, civil engineers were
ready to enter the IT sector, few do so today because of the
vast job prospects available in developing India's
infrastructure. NASSCOM projects that India's emergence as a
preferred outsourcing destination has created the need for over
2 million professionals by 2010. It estimates a shortage of
500,000 skilled workers if remedial action is not taken.

17. (U) To address the potential human resource crunch, NASSCOM
itself is establishing twenty new IIITs (Indian Institutes of
Information Technology) to create highly specialized
professionals with skill sets in emerging technologies that are
not yet mainstream. The first five new IIITs, which will be
established through public-private partnerships, are expected to
be rolled out by 2008. NASSCOM has also partnered with the
Ministry for Human Resource Development to create the "finishing
schools for engineering students" program to equip young
professionals with the necessary skill sets to be directly
employable in the IT industry. This program will help reduce
training costs for new entrants to the industry. NASSCOM has
also launched an industry standard assessment and certification
program - the NASSCOM Assessment of Competence (NAC) - to ensure
a steady stream of employable talent especially for the
outsourcing sector.

18. (U) In contrast, Mehta warned that a downturn in textile
industry employment hurts a particularly vulnerable segment in
Indian society. The textile industry offers job opportunities
for illiterate or semi-literate workers. Moreover, the industry
utilizes unskilled and semi-skilled workers and offers safe
employment to women, he noted. The industry is not location
specific and can be set up even in economically backward areas
of India, Mehta claimed. It costs around USD 250 to create 4-5
jobs in this industry as compared to an expenditure of USD
12,000-15,000 for 4-5 jobs in the IT sector, he added. For
these reasons, Mehta argued, the textile industry, which is one
of the highest net foreign exchange earners for India, should
receive the same favored treatment that the IT industry receives
from the Indian government.

But Booming Domestic Economy Also Creates New Options
-------------- --------------

19. (U) An upside to the booming Indian economy for the IT
industry is that it has also enabled the industry to obtain more
of its revenue domestically and thus hedge against foreign
exchange fluctuation, Vaishnav noted. He pointed out that the
industry currently obtains over 20 percent of its revenues
domestically versus under 14 percent five years ago. He noted
that this trend will continue as the Indian economy continues to

MUMBAI 00000046 005.2 OF 005


grow in productivity. Vaishnav singled out the domestic banking
industry and telecommunications industries for contributing to
this trend. He also believes that the organized retail sector
has the potential to be a future driver. In tandem with this
revenue diversification, the industry has also started
offshoring jobs itself in order to better service clients.
Vaishnav pointed out that the industry has been hiring in China
and in the European Union and is now looking to hire in Vietnam,
Israel and the Philippines. Atul Nishar of Hexware confirmed
this phenomenon, called "near-shoring," and stated that his
company had opened up a software testing facility in Mexico even
though employees receive salaries twice as high as those in
India, to be in the same time-zone as American customers.
Nevertheless, he emphasized that hiring in India is still a
smarter option because of relatively cheap labor costs given the
skill of the employees.

20. (U) Similarly, Mehta admitted that formerly export-oriented
textile companies are quickly tuning their business models
towards India's domestic economy. He informed Econoff that the
booming domestic garment industry has caused nearly all
exporters, including himself, to switch to domestic-oriented
operations. Textile and clothing manufacturers are also
investing in improving the technology used in their factories.
CMAI stated that the industry is also looking to move up the
value-chain into higher quality products which were
fashion-related or technology-related like the bullet-proof
vests and parachute parts that Econoff saw being manufactured
during the recent tour of a textile factory in Surat, Gujarat.
In a separate conversation, Sanjay Lalbhai, Managing Director of
Arvind Mills in Ahmedabad Gujarat, one of India's largest
textile companies, told Congenoff that the rupee's rise has
forced his company to look hard at the domestic market, which is
growing fast. Arvind Mills has exclusive sales and
manufacturing contracts with major foreign clothing companies,
such as Benetton and Tommy Hilfiger, for which there is an
emerging Indian market for higher end clothing.

Comment:
--------------

21. (SBU) Once the main export revenue generator of the Indian
economy, the textile industry now struggles in the shadows of
"new economy" exports, such as engineering goods, petroleum
products, and the IT sector. The textile industry traditionally
was a huge income source for politicians and officials, who
traded much-needed license and manufacturing permits under the
"License Raj" for campaign funds and pocket money. The IT
industry, in contrast, evolved largely outside of government
regulation and political interference, a respite for which its
boosters are grateful. Now, both industries find themselves in
the same boat, facing a rising rupee that erodes profits in an
environment of increasingly global competition. For this, not
surprisingly, representatives of both are turning to the
government for help in advance of the upcoming budget session of
Parliament. Whether the Indian government will provide tax
breaks or other kinds of help is uncertain; what is certain that
once given, tax breaks and other sops are hard to take away,
even when an industry returns to health. In addition, though,
both industries are also trying to diversify and restructure
away from dependence on the U.S. market and the dollar. Not
every firm will succeed, especially the smaller ones, but it is
external pressures such as these that often leave industries
leaner and meaner. Although fraught with political
difficulties, the threat of huge job losses in the
labor-intensive textile industries might be one of the best
opportunities to push the government for more labor flexibility
that allows re-absorption of low-skilled workers. End Comment.
OWEN