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Shipping: Reforms hold the key - Views on News from Equitymaster
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  • Jan 22, 2001

    Shipping: Reforms hold the key

    The year 2000 was a memorable one for shipping companies. The sector witnessed freight rates touching historically high levels after being hit hard by the South East Asian, which resulted in slower growth in world trade. Indian shipping companies also saw their sales and realisations moving up at a steadfast rate, with more than 60%-70% expansion in operating margins. We take a brief look at what happened during the year and what requires to be done to boost the prospects of this sector.

    The Baltic Index, the key indicator of freight rates for the dry bulk segment, recovered from 794 points in March 1999 to touch as high as 2,200 levels during mid September 2000. What led to this buoyancy in the dry bulk segment? World trade, which was hovering around 2% during the Asian crisis (1998-99), went on to touch 3% during the year. This was backed by a significant rise in industrial activity in these regions as well as in Europe.

    The wet cargo segment (which includes crude, petrol and other distillates) also witnessed historically high average earnings per day. Earnings per day touched US$ 50,000 in September 2000 compared to US$ 8,000 in the corresponding period of the previous year. The tanker market, which went through a lean season in the first half of 2000 due to production cuts by the Oil Producing and Exporting Countries (OPEC), recovered in the second in the second half. Wet cargo rates have been on the uptrend primarily due to low oil reserves in the US (US is one of the largest consumers of crude in the world), increase in crude throughput by the OPEC, and inadequate tonnage supply to cater to the growing demand for oil.

    The consequent effect of this is apparent from the first half financial performance of the shipping companies. The Great Eastern Shipping Company (Gesco), the country’s largest private shipping company, reported a sharp 274% rise in net profits for the first half of the current year (excluding extraordinary income from sale of ships). Operating margins moved up from 31% in 1HFY00 to 42% in 1HFY01. The same is the case with the public sector shipping behemoth, The Shipping Corporation of India (SCI). Though net profit declined by 32% in the first quarter of the current year, earnings grew by a healthy 150% in the second quarter (59% for the first half of the current year). Operating margins also increased by 15% to 17% in 2QFY01.

    The buoyant export scenario has contributed to the Indian ports recording good growth in terms of total tonnage handled. Tonnage handled during the year has gone by 5% to 298 million tonnes. The most disappointing factor is that the share of Indian shipping companies has been on the decline consistently for the last four years. Though there was a marginal improvement in the strength of the Indian fleet from 419 ships in 1999 to 515 ships in 2000, tonnage transported has actually declined. So, what hinders growth?

    Lack of incentives subdue growth…
    One of the biggest drawbacks for the Indian shipping companies is the lack of fiscal incentives and inadequate infrastructure facilities. Indian companies generally rely on depreciation and internal accruals as major sources of revenues for augmenting fleet expansion plans. Indian shipping companies, which are one of the highest foreign exchange earners for the country, continue to pay corporate tax, which is not the case abroad.

    In countries like Europe and Turkey, there is a concept called ‘tonnage tax’. On every dwt (dead weight tonnage) that a shipping company owns, the incidence of tax is calculated. So, shipping companies need to pay just a fixed amount as tax, irrespective of whether these companies make a profit or loss. Though it is double-edged sword (i.e. the companies may have to pay that fixed amount during lean season also), it has the benefit of limiting tax upfront. This system also enables companies to schedule their fleet acquisition programs based on future cash flows.

    Another reason that is often cited as a disadvantage to the Indian shipping companies is that they have to necessarily register their ships in India, whereas this is not the case abroad. Internationally, shipping companies are allowed to register their ships in some tax haven, popularly known as Flag of Convenience (Panama, Liberia or Bahamas). This results in lower incidence of tax. In fact, more than 20% of world fleet is registered in Panama. Though the industry and the representative organizations have been insisting to introduce such a tax system, there seems to be no reform initiatives from the government, till now.

    Overcapacity concerns…
    The other major concern is the increasing number of new ship building orders and fear of oversupply of tonnage in the markets. Usually, shipping companies tend to augment their tonnage when freight rates edge upwards, to take advantage of higher rates. Moreover, stringent environmental regulations, particularly in the European union, led to huge scrapping of existing tonnage as these countries banned old ships from plying into their coastal regions.

    However, it has been reported that more than 15% of scrapped tonnage has already been ordered. This coupled with the slowing US economy might subdue freight rates for the shipping sector.



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