The operating margin of domestic cotton yarn spinners is expected to shrink by 2-4 percentage points in the 2020 fiscal following higher domestic cotton prices and a sharp fall in exports, according to a report.
A narrowed spread between cotton and yarn prices compared to the last fiscal would also impact the margin, CRISIL Ratings said in the report.
Higher domestic cotton prices compared with international prices during April-October 2019, a sharp fall in exports mainly to China and Pakistan and the resultant domestic oversupply is likely to lead to this squeeze, it added.
"While domestic demand (70 per cent of domestic production) is expected to grow 3-4 per cent this fiscal, supply has been higher because of lower exports. The US-China trade war has impacted demand for yarn in China, while the Indian government has banned yarn exports to Pakistan.
"China and Pakistan (accounting for 35 per cent and 5 per cent of yarn exports, respectively, in fiscal 2019) have reduced imports from India by 50-60 per cent this fiscal," CRISIL Ratings Director Gautam Shahi said.
As a result, he added, exports in the first seven months of fiscal 2020 are lower by 38 per cent leading to higher domestic inventories and pressure on spreads.
"Considering recent reduction in domestic cotton prices to Rs 105-115 per kg and stable international cotton prices, profitability of spinners in the second half (of current fiscal) should be higher than in the first half. However, this may not be sufficient to offset the steep negative impact on profitability seen in the first half," CRISIL Ratings Associate Director Sushant Sarode said.
The impact on the margin will vary with size and product profile of the companies, operating margins for large spinners (having a capacity of over 50,000 spindles) could be lower by 200 bps (2 per cent) in fiscal 2020, while the impact on mid-and small-sized spinners (with less than 20,000 spindles) could be twice that.
The report further explained that the dynamics of the spread between international and domestic prices of cotton also affects profitability.
International cotton prices declined 15 per cent between April and October 2019, following a bumper crop in Brazil and the US, and destocking by global consumers, mainly China, it said.
On the other hand, domestic prices fell only 10 per cent during this period because of an increase in minimum support price (MSP), which rendered India's cotton yarn exports uncompetitive, it pointed out.
Cotton output is expected to improve with late recovery in monsoon and increase in sowing area to 127.7 lakh hectare, 6 per cent higher than last year, putting pressure on domestic cotton prices, which could slip below the MSP unless there is policy intervention.
On the other hand, international cotton prices are expected to remain range-bound until tariff issues between the US and China get resolved, the report added.