Many observers saw Blackstone's recent $165m offer for a majority stake in India's largest garment exporter, Gokaldas Exports, as a coming of age for the country's apparel sector. But Mike Flanagan believes instead that it exposes many doubts about the underlying health of the Indian industry.

There's a lot of excitement in India about private equity.

In August, Gokaldas Exports, by some measures the country's largest apparel exporter, recommended its shareholders should accept an offer from US private equity specialists Blackstone.

To many Indians, the offer from Blackstone marked a coming of age for India's apparel industry. But it exposes many doubts about the underlying health of the Indian industry - as well as about the judgement of Indian investors.

Let's start with the offer itself. Its INR275 per share is almost precisely half the value the market put on Gokaldas when it went public in April 2005 at a share price of INR566.

Over the same period, there's been a tripling of the Sensex, the key index of the Bombay Stock Exchange.

And it's not just Gokaldas that's spectacularly underperformed the market. Since the beginning of this year, Indian shares overall have gone up in value by about 25% - but  clothing and textile shares have fallen back about 5%.

Clothing and textiles just aren't where smart Indian money's been going lately, in spite of a mini-spurt since Blackstone's offer.

So one major motive for Blackstone was simply that Gokaldas was going cheap.

"Significant impetus"
True, Gokaldas claims: "With Blackstone's relationships across the world, our customer profile is likely to get a significant impetus."

But since Blackstone's active relationships don't include any customers for the things Gokaldas makes (Blackstone has tried to lend money to lots of apparel retailers, but none have ever accepted its offer), and Gokaldas' current customers are about as impressive a group as it's possible to find in our industry, it's hard to see how Blackstone can help Gokaldas' marketing effort.  

Gokaldas has had a reasonable record of sales and profit growth since its 2005 flotation, though some local analysts are forecasting miserable results for the next quarter. It's got good customers and good management.

At a total bid cost of $165m, it's a relatively small gamble for Blackstone on a possibly high increase in value - especially since Akhil Gupta, managing director of Blackstone in India, claims his US colleagues would not normally do a deal below $250m.

But Blackstone doesn't bring much-needed expansion capital to a country that's in desperate need of it. India's stock-market boom shows there's no shortage of Indian investment money: it just doesn't want to invest in our industry.

Blackstone's real benefit to Gokaldas is it makes expansion capital easier and cheaper, when India's banks are making credit dearer. 

Colonial legacy
But why has this well-run, profitable business halved in value when the rest of Indian industry has tripled?

I'd suggest it's because India is relying on the wrong bits of its colonial legacy.

India-boosters love to claim India's a better long-term bet than China because of its democracy and the widespread use of English. Both are two-edged swords for the health of apparel and textile companies.

India's democracy is the main reason India's apparel production facilities lag so sadly behind China's. Its "job for life" laws make it virtually impossible for apparel companies to lay off staff when orders are low - and that discourages factories from expanding.

It's over two years since the Indian government promised it would reform these laws "within a year" - and it's not indolence, but dogged parliamentary opposition stopping this much-overdue change.

The belated realisation that many Indian peasants were unhappy at losing their land to apparel parks has also put a huge brake on the country's long-planned factory expansion.

And the same need for near-universal assent to any other change is the main reason Indian manufacturers have to use such awful - and slow - roads to get their products to ports.

And English? Well, one effect of widely spoken English is that India's apparel exports are heavily skewed to the UK and US - and even there in just a handful of categories of cotton clothing.

China hasn't just developed markets outside the EU and US (including, most spectacularly of all, Japan) - it's done a great deal better than India in those parts of the EU where English isn't the main language. Which means the UK and US account for only 18% of China's clothing exports.

Freedom of speech
So what's the colonial legacy India's investors should have paid more attention to? 

Freedom of speech is one. India boasts in public of this freedom - but its laws allow criminal charges to be brought against human rights campaigners for publicising abuses.

This, claims Amnesty International, is in clear breach of the 1998 United Nations Declaration on Human Rights Defenders.

These laws prevented local trade unionists from publicising abuses in July 2006, and Bangalore-based Fabrics and Fibres International (FFI) is now exploiting them to try to intimidate activists at the Dutch labour rights group Clean Clothes International

FFI isn't helping its credibility - or the credibility of other Indian manufacturers - in the international buying community by conducting its intimidation campaign with hysterical silliness, including among its charges "acts of racist and xenophobic nature."

The results of this absurd campaign are totally predictable: far better-resourced organisations than Clean Clothes International - like London's Rupert Murdoch-owned Sunday Times newspaper - are now queuing up to print stories about Indian worker abuse.

These stories include allegations about a subsidiary of Gokaldas Exports, which will keep undermining Gokaldas' reputation.

As long as India tolerates laws that suppress exposure of exploitative working conditions it's going to find buyers increasingly suspicious of any reassurances its manufacturers offer, and international media convinced it's hiding something.

Misplaced sense of triumph…
The other overlooked colonial legacy is India's formidable array of English-language authors, from Calcutta-born Rabindranath Tagore to Bombay's Rudyard Kipling, whose best-known line has to be:

"If you can meet with Triumph and Disaster, and treat those two impostors just the same, you'll be a Man, my son."

Now if there was ever a group of people with a misplaced sense of Triumph, it was India's investment community at the beginning of 2005, when apparel and textile quotas came off.

Although India had never fully used any of the quotas it had from the EU and US, India's standard-bearers convinced themselves the world was queuing up to buy its clothes.

And it never occurred to any of them that India's textile (as opposed to clothing) exports were mostly to Western  countries that used the fibre and fabric to make into clothes - a business that started disappearing the moment quotas went.

Quota abolition wasn't going to transform Indian apparel and textile companies' fortunes overnight, but it did make it easier for some Indian companies to compete for European and American business.

As it happened, Indian companies increased the volume of clothes they sold to the US and EU substantially, with their global market share growing from 3.8% in the first half of 2004 to 5.2% in the first half of 2007.

But the gap between the success of Indian and Chinese companies widened, and India's growth was far slower than the growth in, for example, Bangladesh or Vietnam.

India's growth was also heavily concentrated in embroidered cotton blouses and skirts - fashionable in 2005 as quotas went, fooling many observers into overestimating the real growth in Indian apparel exports - but now no longer at the cutting edge.

Indian clothes exporters added relatively little to their manufacturing capacity compared to the Chinese, often preferring (probably wisely) to invest in marketing operations, especially at home in India.

They were, compared to Bangladesh, expensive, though prices for European and American customers came under intense pressure - with the result that Indian companies' volume gains were often at the expense of profits.

They showed none of the business innovation at the top end of the industry like Sri Lanka.

Far too many Indian manufacturers wrongly thought they could succeed in the hyper-competitive world post-2005 with the same soporific approach to selling that worked when access to Western markets was controlled by the quota system.

…but no disaster
But, to go back to Kipling, the post-quota world wasn't a Disaster either. The road to US exports wasn't paved with gold - but no-one went bust, and Clothesource Tradetrak shows that Indians exported 68% more clothes to the West in the first half of 2007 than they managed in the first half of 2004.

Indian investors had preposterously naïve expectations of what would happen after quotas disappeared; they also over-reacted to a couple of years of good, but not earth-shattering, results from India's major apparel exporters.

A bit more reading of Kipling, and a great deal less time on teenage consultants' sillier prognostications, and they'd have had sensible expectations when Gokaldas was launched, and sensible reactions to two years of steady profit growth afterwards.

Instead, of course, there's a great deal of talk in India at present about the apparel and textile industry missing boats, golden opportunities being allowed to slip away and all the other Disaster-speak Kipling was so scathing about.

And the recent sharp increase in the value of the rupee hasn't helped confidence in India either.

Reality bites
But it's all nonsense.

• India's economy is growing far faster than almost any in the world. Its people will increase their spending on clothes even faster, and India will retain some of the world's toughest protectionist barriers against foreign apparel and textiles. Indian companies producing for the domestic market are going to be making a lot more money over the next few years.

• India's not losing the battle for international apparel sales with China. It was never in a battle with China, which currently sells nearly seven times as many clothes to the US, EU and Japan as India. And the gap between them has widened each year since quotas went. Since the two countries simply aren't in the same league, comparisons between them are as pointless.

• Well-run, customer-focused apparel producers in India are just as capable of making money in foreign markets as businesses in Sri Lanka or Cambodia. But it's never going to easy: with good manufacturers in practically every single low-income country on the planet, supplying garments to customers in the EU and US will always be one of the most competitive ways of making money imaginable. But it's possible

Two fundamental weaknesses
India has to recognise one fundamental weakness it suffers compared with many other apparel manufacturing centres - or rather two linked weaknesses. It's unusually dependent on locally-manufactured fabric, and its currency is under serious upward pressure.

And that's a fatal combination. Back in 2004, many naïve Indians thought India's large fibre and fabric industry was going to be an advantage to its apparel manufacturers. Three years on, things are looking very different.

India's garment and textile industries are convinced they're uniquely hurt by the currency's appreciation. They're not: compared to the US dollar, the Indian rupee is currently worth 14% more than it was in October 2006.

But there's scarcely a currency in the world that hasn't appreciated against the dollar. Turkey and Brazil - which once had almost daily devaluations - have currencies worth 20% and 16% respectively more against the dollar than last year. And the Dominican peso is worth a staggering 256% more than it was five years ago. 

India's problem isn't just an appreciating currency: it's that most other apparel manufacturing countries import a lot of their fabric - and therefore, as their currency has appreciated, the fabric has at least got cheaper.

Right now, India's dependence on locally-manufactured fabric is worsening its competitive position. Wherein lies the real lessons of Indian apparel exporters' current predicament:

• India will, for some time, remain a rapidly growing apparel market with considerable protectionist barriers against foreign apparel imports. So its best apparel makers' profits from domestic sales are going to show healthy growth for many years to come.

• Indian manufacturers have far fewer competitive advantages on the international market than its more naïve boosters have been claiming. Indeed, its laws - including those that suppress free speech - and infrastructure are serious obstacles many other countries' manufacturers aren't burdened with.

• But national competitive advantages are practically impossible to predict. No-one foresaw three years ago that India's currency would appreciate so much against the dollar and euro. Who knows what other changes there'll be in the next three.

• Buyers buy from companies, not countries. With India's present laws and infrastructure, being in India is a barrier for any apparel manufacturer on the international market. But good companies - like Gokaldas Exports - are good because overcoming barriers is what they've learned to do.

Or, as Rabindranath Tagore put it: "What are obstacles to the lower creatures are opportunities to the higher life of man." 

Good investment is about finding management teams who can spot opportunities and exploit them successfully. And that's what Blackstone has done with Gokaldas - wherever the rupee appreciates to, and whether Gokaldas finds those opportunities in the US, at home or in Brazil.

Mike Flanagan is chief executive of Clothesource Sourcing Intelligence, a UK-based consultancy that provides the western apparel buying community with objective information on apparel production, trade, price competitiveness, and apparel producers in over 100 countries.