February 2005
COVER STORY

Garment Industry: Time to Stitch a Niche

By Madan Lamsal and Keshav Gautam

What went wrong with the development of Nepal's readymade garment (RMG) business as an industry despite its over two decades of existence? What are the lessons for the other sectors? And what should be right strategic matrix now for its future?

These are some of the questions haunting Nepal now as the over two-decade old RMG industry of the country was found not prepared to face the competitive world market that has now emerged after the Agreement on Textile and Clothing (ATC) expired at the end of year 2004 eliminating the quota system. This date was fixed good ten years ago and the government as well as the garment entrepreneurs were already aware of this fact from the very beginning.

As can be concluded from what Kiran Saakha, the president of Garment Association-Nepal (GAN), the chamber that represents the sector of the country, told this magazine (Nubiz January 2005), this industry is as good as dead unless some miracles happen and the quota system is revived in some form. In a free market environment, Nepal cannot compete even with Mongolia, according to Saakha as Mongolia has developed considerable competitive strength in recent years by inviting foreign investment in this sector.

To be sure, it is still not time to write the obituary of Nepal’s RMG industry as some exceptional cases of units may still be doing alright even in the post-quota days due to the strong relationship they have developed with the buyers. As the garment entrepreneurs have been saying, there is still hope for getting some concessions to sell Nepali RMGs in the United States, the largest market in the quota system for Nepali RMG. Therefore, many units have not wound up their business.

Source: Bajaj as quoted by Navin Dahal

But the Nepali authorities do not seem to be ready yet to do what the garment entrepreneurs are suggesting them to get the US advantage. For example, the government is quite unwilling to pay the excess charge that a power project, partly owned by a US firm, is demanding from Nepal Electricity Authority. This is believed to be one of the reasons why there is no progress in desired direction in Washington. The firm is believed to have considerable clout on the US Congress which has to pass a special law that will allow Nepali RMG some special facilities to enter the US market and for while the industry is lobbying in Washington.

One reason for the lack of seriousness from the authorities is their perception that the RMG entrepreneurs enjoyed the cream when the industry was doing well and made no investment in improving the competitive strength.

It is not that the industry was not doing anything to analyse the impending situation. There were several studies conducted by using domestic as well as international consultants to find out what should be done to face the future. Some suggestions of these studies are worth mentioning (see box in page 40). They are not only still valid for RMG sector but equally applicable also to other export-oriented industries.

The list is not exhaustive. However, it is more than sufficient to show that the industry as well as the government had lent a deaf year to the expert suggestions.

What can be done now?

Despite the gloomy picture that some analysts try to depict, Nepali garment industry still has some hopes, as Saakha was saying to New Business Age last month. And he seems to have reasonable basis to have such optimism.

First, contrary to the general predictions, the world RMG market is not likely to be controlled by China and India only. Like Nepal, both of these countries are dependent on imported fabric for the RMG they make for export despite their well developed textile industry. Second, there are already signs that the labour and other input costs for these countries in RMG sector are going to shoot up due to the pressure of demand.

Therefore, the RMG companies of these countries may search for other cheaper locations to make the goods for which they receive orders from US buyers due to their specialized image as efficient producers. Thus, there is a chance that Nepali garment industry will get similar spill over benefits even under quota-free regime as they got during the quota regime.

Moreover, the garment companies from these countries would be attracted to locate their production in Nepal due to the Generalised System of Preferences (GSP) facility that as an LDC Nepal gets also during the post-quota period to export to some markets such as European Union, Canada, Australia and Japan. Despite these being small markets when compared to the USA, they are in no way insignificant. More importantly, though the GSP facility is unilateral and can be withdrawn by these countries, the EU has promised to continue it till the end of 2006. The breathing period thus received can be utilised by Nepali RMG units to regain their strength.

For an industry to compete in the international market, it should either have a cost advantage or unique products. Therefore, the Nepali garment entrepreneurs have to make a choice between these two options. If they want to continue producing and selling the mass market items as they were doing in the past, they have to have cost advantage. For this they have to go for enhancing productivity and produce in large scale as the Chinese manufacturers are doing. This seems very difficult to achieve in the short period that is available. Though the Nepali RMG units are designed for bulk production, they are not big enough to compete with the bulk manufacturers of other countries. Probably they were scared of employing large number of people due to the rigid labour law.

The second option has further sub-options. One is producing unique products, such as based on indigenous Dhaka cloth or other designer dresses. This requires time to develop the dress designing capacity. Hiring international designers is going to be costly and it may require some time before unique dresses designed and manufactured in Nepal become acceptable in the world market.

The other option is to compete on the basis of flexibility in production. This requires capacity to accept orders of small lots and ability to handle frequent change in the style of the goods.

Nepali RMG units may compete also on the basis of value addition. It requires production of complex products such as brassieres by Sri Lanka in which that country has already established its market leadership. Similarly, India too is capable to compete on the basis of its capacity to handle complex products that involve a lot of embellishments, such as embroidery, printing etc.

Of course, these option require a lot of preparation and restructuring of the production units and training to the labour force.

Therefore, industry analysts suggest that Nepali players should now try to take maximum possible advantage from the new markets like EU, Australia and Japan and fast improve their competitive strength while these markets are available at concessional terms, focusing on the parameter that they want to compete in the global market. They may also decide to compete in the global market on the basis of scale. Though individually they are small, they can be big if they go about it together by pooling their resources.

Whatever they do, they have to decide on their niche – either standard products that need big volume and scale or product lines that need flexibility and variety or in which there will be high value addition though the volume may be small.

One business model can be what Surya Nepal is following. It is exporting RMG to India on the basis of its special relations with ITC (its principal), which has good marketing network across India. Meanwhile, it is also foraying in other markets. The basis of competition selected by this company is flexibility. Also the training of the human resource and selection of machines are based on the principle of flexibility. For example, the workers are trained in multiple skills so that if one or two workers are absent for some reason, the work does not stop. Exercises for the workers are designed to improve their dixterity and agility.

Also the workstation design is such that (U-shaped) six workers can handle nine machines simultaneously, thus ensuring higher productivity. It has installed latest machines to improve efficiency. For example, it has automatic cutting machine even for check shirts, which is the first such facility in the entire SAARC region.

Whichever strategy or model the Nepali RMG industry may select, one thing, however, is certain. In this process, the industry will have to go through a very painful restructuring process. Their success will depend also on the support they get from the banks and the government.

Phasing out of
Apparel Quota:

Future
Strategies
for Nepal

The application of the quota system under the Multi-fiber Arrangement (MFA) was the main reason for the growth of apparel industry in Nepal. In the early eighties Indian exporters constrained by the lack of quotas turned to Nepal resulting in a sharp increase in the export-orientated garment manufacturers. The number of firms in this sector grew from 58 in 1982/83 to 1067 in 1994/95. The number of firms however, declined after 1994/95 and came down to 212 in 2000/01 and approximately to 100 in 2004.

Today, the export-oriented garment industry plays an important role in the Nepali economy. It contributes 10 percent of the country’s manufacturing, 40 percent of export earnings from export to countries other than India, and provides direct employment to 50,000 and indirect employment to additional 50,000.

The US is the main destination market for Nepali readymade garments. Till 1999/2000, almost all the garment exports were to the US. The total exports and the share of US export in the total exports have declined after 2000. Export in 2004 was only 57 percent of export in 2000. Export to the US has also gone down and in 2004 it was only 52 percent of the export in 2000.

Nepali garment export to the US was based on quota and was subject to an average 14.6 percent duty whereas export to the European Union (EU) and Canada was under Generalised System of Preference (GSP). In other words, Nepali exports had duty free access to these markets. In spite of this scheme, due to the high cost of production in Nepal, Nepali exporters were not able to increase exports to the EU.

Nepali readymade garments export to the US is limited to a few product lines and the quota utilisation in all the product categories except for cotton trousers and shorts has been very low. This is because of Nepal’s higher cost of production and longer delivery time compared to neighbouring India and other low cost producers such as Bangladesh. Nepal’s production and delivery cost is estimated to be about 25 percent higher than that in the neighbouring countries.

International Apparel Industry

International trade in textile and clothing has been distorted for the last 40 years. Some developed countries including Canada, the EU countries and the US had limited the imports of textile and clothing from “low cost” developing countries through various arrangements.

The quota system in the textile and clothing sector was introduced to protect the textile and clothing industries in the developed countries from competition from “low cost producers” in the developing countries. This, however, also helped many countries including Nepal to enter this industry. The quota system also distorted international trade in this sector. The quota system of textile and clothing came to an end on 31 December 2004. Though different types of uncertainties make it difficult to predict the situation after the quota elimination, the future in this industry is likely to be shaped by the following factors:

Decreasing Prices

The prices of apparel are likely to fall in post quota regime. It is estimated that there will be an average 20 percent reduction in the US wholesale prices. The 53 percent fall in the prices of items on which quota was removed in 2002 in China also indicate that the prices are likely to fall.

Domination of few Efficient Exporting Countries

China and India are likely to dominate the apparel industry. A recent study conducted by the WTO has predicted that China and India will increase their market share in the US apparel market to 56 and 15 percent from the present 16 and 4 percent respectively (Nordas 2004, 30). This is likely to come at the expense of less efficient countries like Nepal. The actual gain in market share, however, is likely to be less than this as many experts feel that China does not have the industrial capacity to increase its market share to a very high level. Also the capacity of India to substantially increase its market share is doubtful as the apparel sector was for a long time reserved for small and cottage industries. This prevented investment in large efficient enterprises.

The importers are also not likely to put all their eggs in China and India baskets.

Tariff and other Trade Barriers

Tariff and other trade barriers such as requirements for eco-labeling, social and environmental clauses, workplace code and respect for intellectual property rights (IPRs) are likely to dominate apparel trade in the quota free era.

Domination of Preferential Trading Arrangements

The future apparel trade will also be dominated by preferential trading arrangements. These arrangements have already influenced exports to the EU and the US. The North American Free Trade Agreement (NAFTA) diverted US clothing import from Asia to Mexico. The US also provides duty free access to Caribbean Basin countries under the Caribbean Basin Trade Partnership Act (CBTPA). The African Growth and Opportunity Act (AGOA) of 2000 has granted duty free access to 19 sub-Saharan African developing countries to the US market.

The EU has also established the outward processing trade (OPT) to shift production of textile from high cost Western Europe to low cost East Europe. The EU also has special arrangement that gives duty free access to apparel exports from Morocco and Tunisia.

Strategic Options for Nepal

As the garment industry plays an important role in the Nepali economy, all efforts need to be made to ensure that this industry does not collapse. Some immediate, short term and long term measures that need to be taken to ensure this are listed below.

Ensure Preferential Market Access

With around 80 percent of the total garment export to the US, the Nepali garment industry is totally dependent on this market. In the quota free regime, Nepali garments, which are 25 percent costlier than in the neighbouring countries, will not be able to compete with products from these countries. Without a duty free access to the US market (which has an average 14.6 percent duty on Nepali garment exports), Nepali garments will not be competitive in the US market. Nepal should thus put all its efforts to get this facility from the US.

At the same time, the private sector and the government need to sit together and work out a plan to increase share in the EU market.

Implement Measures to Improve Competitiveness

Though preferential market access will give breathing space to the Nepali garment industry, Nepal will have to address the supply side issues to remain competitive. As Nepal will not be the only country receiving such facility, competitiveness is what Nepal will have to develop to remain a preferred country of sourcing. Establishment of a Garment Processing Zone (GPZ) near the Inland Container Depot in Birganj, establishment of Technology Upgradation Fund to provide subsidised loan to the private sector to upgrade technology, procedural simplification to reduce cost and time are measures that need to be started immediately. The establishment of GPZ will help to reduce cost and improve lead-time.

Government needs to make appropriate amendments in the laws to make them investor and productivity friendly. The skills of workers will also have to be upgraded to increase their productivity.

So far, marketing played a very small part in Nepali export of garments. The private sector will now have to improve their marketing to get orders, as they can no more rely on the availability of quota. This is not an easy task and on this issue too, the private sector and the government need to work together.

Given the fact that issues such as eco-labeling, social and environmental clauses, workplace code are going to gain more prominence in the post quota textile regime, Nepal also needs to address these issues.

Long Term Measures

On the long run, only those countries that are backward integrated are likely to remain competitive. The government thus will have to promote textile and other ancillary industries.

Duty free access to the US and EU markets will be a strong motivating factor for Chinese and Indian companies to set up joint venture companies in Nepal. This can prove vital for bringing in new technologies and skills. This will also help to improve Nepal’s image as a supplier. The government thus, should promote strategic alliances with Chinese and Indian companies.