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BW Businessworld

That Sinking Feeling

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In early 2007, H. K. Mittal, the 63-year-old chairman of Mercator, decided to diversify his portfolio even though his flagship sea transportation business was growing at a scorching pace. He deployed the company’s profits in coal mining and hydrocarbon exploration businesses.

While Mittal’s contemporaries were surprised, it wasn’t long before his move proved right. Within a year, the global economic downturn took its toll on the shipping business, with freight rates falling and operating costs rising. The US banking crisis was followed by the euro zone meltdown and the shipping industry continued to flounder. In the past five years, Indian shipping companies, too, have witnessed a significant drop in their numbers (see Going Under).

Having seen the writing on the wall, Mittal pruned his revenues from shipping down to 26 per cent in 2012 from almost 98 per cent in 2005. “Today, coal is our flagship business, with a 63 per cent revenue share. The share of shipping will fall further to 20 per cent in the next 18-24 months,” says Mittal, who rechristened his company Mercator Ltd from Mercator Lines to better represent his diversified business.

Around the same time, Yudhisthir Khatau, vice-chairman and managing director of Varun Shipping, with the largest fleet of vessels that can transport liquefied petroleum gas (LPG) in India, transferred the parent company’s shipping assets to overseas associate companies based in zero-tax zones, so as to avail complete tax exemption. “We shifted the base to take advantage of crew flexibility and to get long-term contracts,” says Khatau.

The tax structure in India forces many shipping companies to register their vessels in zero-tax zones such as Singapore and Cyprus. Moreover, a Singapore-based ship can recruit crew of any nationality and the employees do not have to pay any taxes on their remuneration. On the other hand, the crew of an Indian ship has to pay 30 per cent tax, making it difficult for Indian ships to get good crew.

Though both Mittal and Khatau have chosen different paths, their moves point to the disintegration of the Indian shipping industry. But, the phenomenon is not restricted to India. Across the world, the shipping industry is facing a downturn, thanks to the economic crisis and the glut of new ships ordered during the pre-2008 boom. “Charter rates have fallen below break-even levels and the tough economic conditions have bankrupted several global shipping firms and forced others to restructure,” says Anil Devli, chief executive officer, Indian National Shipowners’ Association (INSA).

Shipping companies in India are facing several other issues. High taxes and a lack of financial support have squeezed margins. They even have to pay from their pockets to combat piracy. “This is a terrible situation. The industry has been sinking over the past four years,” says S. Hajara, former chairman of the Shipping Corporation of India (SCI). “There is no clarity on when the turnaround will happen.”

Trouble On Board
Historically, India was at the forefront of maritime trade. But over the last century, it has slipped due to administrative disinterest and a lack of investment. Meanwhile, China has emerged as the world’s largest ship-builder. However, G.K. Vasan, Union minister for shipping, counters this view. “It is erroneous to say that we have lost the edge and that the maritime sector is in decline.” The Indian merchant shipping fleet has grown from 5.98 million gross tonne (MGT), consisting of 408 ships, in 1990, to 10.3 MGT, comprising 1,184 vessels, in 2013. The cargo handled at our ports has grown from a mere 30 million tonne (MT) in 1960-61 to about 930 MT in 2012-13.

While these figures are impressive, the fact remains that Indian carriers control a mere 1 per cent of global shipping and carry a total tonnage of just 4 per cent.

So, why is the Indian shipping industry sinking? There are several reasons for this. High taxes, lack of funds and special status for Indian vessels being among them. A.R. Ramakrishnan, managing director of Essar Shipping, explains: “Foreign vessels have a cost advantage over us. Moreover, we are not given any preference in carrying national cargo.” 

If the government provides incentives like cargo reservation for Indian vessels, the industry could be rescued. Both China and Indonesia have a cargo-support policy for their vessels.

On paper, Indian ships too get support. Under Transchart, they get the right of first refusal for shipment of government-controlled cargo, provided they match the lowest price quoted by foreign vessels. But due to high operational costs, Indian ships can almost never match quotations of their foreign counterparts, let alone offer a lower price.

Moreover, support to the industry has been shrinking over the years as several public sector companies in the oil and steel sectors have been allowed to bypass this arrangement. While Indian ships do get preference in carrying coastal cargo, under the cabotage policy (no foreign ship can engage in trade between ports in India except under licence), it accounts for just 7 per cent of the shipping industry’s revenues.

Vasan claims his ministry is working towards providing a cargo support policy. “The ministry is also contemplating reserving certain national cargo of PSUs for Indian ships; say, 30 per cent initially,” he says.

Taxing Issues
Indian shipping companies have to pay higher taxes than their foreign counterparts. For instance, Indian ships have to pay service taxes on all ancillary services that foreign ships are completely exempt from. Moreover, for Indian ships, service tax is applicable on coastal trade and time charter arrangements as well.
Further, any notional income arising from the operation of a ship is taxed at the normal rate under the tonnage tax system introduced in 2005. Tax is payable even in the event of  loss during a financial year.

Having to pay a bulk of their earnings in taxes, Indian shipping companies have now requested the finance ministry to grant them infrastructure status as, in the absence of such a tag, they have to pay 35 per cent duty on equipment for welding, cutting and bending. They have also requested a tax exemption for crew. 

Hajara stresses the need for a friendlier tax policy. Over time, policies have become harsher for the shipping industry. For instance, while there was no excise duty applicable on ships built in India until 2011-12, Indian shipyards now have to cough up 5 per cent.

Though the government has provided ship-builders a subsidy of 30 per cent, the incentive only kicks in when the ships are delivered, which is several years down the line. As a result, ship-builders are forced to quote higher prices to clients, and not those post-subsidy.

Struggle For Funds
Another woe of the shipping industry is the lack of funds. Ramakrishnan says banks do not lend to Indian shipping companies because of the absence of long-term contracts. However, according to Vasan, “The government is working on a long-term cargo support policy with oil- and coal-importing industries. Shipping companies can use these long-term contracts as a guarantee for funding from banks and institutions.” He added that the ministry was also trying to provide long-term funding at attractive rates.

Globally, too, banks are cautious about lending to the shipping sector. “European banks, in particular, are facing the challenge of exposure to risky assets in their own economies and are not likely to take on fresh exposure to shipping in markets like India that are perceived to be risky,” says Khatau of Varun Shipping, which currently in is in the throes of a crisis as the director-general of shipping has threatened it with action for failing to honour its financial commitments, including payment of wages.

Diminishing Returns
India Ratings, a ratings agency, has put out a negative outlook for the shipping sector and says the industry is unlikely to see a revival until 2015. “Capacity overhang brought on by low levels of international trade and high fleet additions is likely to keep freight rates muted across the primary segments of dry bulk, tanker and container carriers in 2013,” its report states. Operating margins will also be hurt by high fuel prices and low revenues, it adds.

Reduced profitability in 2013 is also likely to hamper the debt repayment capacity of domestic shipping companies, particularly those that embarked on a debt-fuelled capital expenditure plan around 2007-08, when asset valuations had peaked. The sharp depreciation in the rupee over the past two years has further added to the woes of companies that borrowed foreign money to fund asset acquisitions.

The only bright spark is charter rates in the offshore segment, comprising oil rigs and support vessels, which remained high in 2012-13. These rates were supported by increased offshore exploration and drilling activity, which in turn were driven by persistently high crude prices, says the report.

On the other hand, charter rates across the three broad shipping segments — dry bulk, container lines and tankers — have remained subdued. The highest year-on-year (y-o-y) fall in 2012 was exhibited in the dry bulk segment (42.2 per cent), with the Baltic Dry Index falling below October 2008 levels.

While container ship rates fell by around 32 per cent y-o-y, they were still well above the levels seen in 2009. Rates for tankers, despite falling 8 per cent, have exhibited the highest stability amongst the three. This is attributed to the lower volatility in global trade in crude oil and derivatives compared to the trade in iron ore, coal and manufactured goods.

SCI has been banking on its offshore division, even as its bulk carrier and tanker divisions continue to pose concern. In August 2012, SCI announced that it would invest around $114 million to acquire six offshore vessels. It also plans to spend up to $250 million to acquire 10 more offshore vessels in the future. Great Eastern (GE) Shipping too has lined up a capex of around $450 million for the purchase of eight ships for use in the oil exploration industry.
Despite the big plans of some industry giants, experts feel that the core business first needs to return to normalcy. Shipping lines have been struggling to stay afloat as the operational costs keep rising, while the revenues see a steady fall.

Global Competitiveness
Apart from these problems, the shipping industry in India is also grappling with high ship calling costs compared to other countries in the region. Consider this: port calling costs for a ship that can carry 1,200 standard cargo containers is $19,000 in Kochi compared to $3,300 in Colombo. Berth hire charges at the Chennai port are almost six times higher than at the Singapore port, which is the busiest in the world. The port of Singapore handled 538.3 million tonnes of cargo in FY12, which is more than 96 per cent of the total cargo handled by all the 13 major ports in India.

Internationally, ports provide various facilities to increase their appeal. According to an EY report, the ports of Rotterdam and Amsterdam in the Netherlands provide a whole range of tax incentives to shipping companies such as tonnage-based taxation, accelerated depreciation, regressive depreciation, investment deduction and zero rating for value-added tax purposes.

In China, ships registered under the Hong Kong Merchant Shipping Ordinance are exempt from profit tax on the income derived from international operations, according to the report.

India doesn’t provide any such facility. Currently, around 70 per cent of Indian container cargo is being transshipped from the ports of Colombo, Singapore, Dubai and Salalah in Oman. Transshipment from foreign ports makes a country’s imports costlier and exports less competitive due to increased transit time and additional port costs, the EY report points out.

Shipping being a global business, all players are directly affected by the current downturn, says a GE Shipping official. With low earnings from freight, there is little that shipowners can do on the revenue side. The only area within the control of shipping companies is operating costs.

However, even here there is limited scope for curtailing costs without affecting the safety of cargo and personnel. The key is to have strong financial discipline on the overall balance sheet, says the official.

There has already been a spate of high-profile bankruptcy and loan restructuring cases and more are expected. A large-scale scrapping of vessels is called for to help bridge the demand-supply gap, says the GE Shipping official.

Our sea-faring heritage is in danger of being wiped out. A collective effort from all stakeholders is needed to keep the shipping industry in India afloat. 
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(This story was published in BW | Businessworld Issue Dated 10-02-2014)