BMI View : The fallout from the Crimean dispute on global financial markets is set to impact Indian drugmakers. The rouble and the hryvnia have tumbled against the rupee, wiping out some of the cost advantages that Indian companies enjoy against competitors. With prices fixed on a considerable proportion of medicines on the market in Russia , the impact of these currency movements will be felt on the profit line for many Indian generic drugmakers.
The crisis in Ukraine involving Russia and the subsequent annexation of the Crimea has had considerable macroeconomic consequences; the Russian rouble experienced a considerable sell-off in the previous two months as capital flows reversed and investors sought safer assets in developed countries. Similarly, Russian companies and citizens traded roubles for dollars to hedge against further devaluation amidst a climate of heightened volatility on the currency and capital markets.
While the impact has not immediately filtered through to multinational companies with local subsidiaries in the country, the implications of the events in Crimea will be undoubtedly be felt at the end of quarter when cash is repatriated from Russian subsidiaries to their country of residence. As a result, investors in Indian pharmaceutical equities have sold off positions, with the benchmark BSE Healthcare Index down by 5.9% over the two week period between February 28 and March 18, although some of this decline was attributable to bearish sentiment following FDA warnings prior to the events.
| Rouble And Hryvnia Sell Off To Hurt Indian Companies |
| INR-RUB and INR-UAH Spot Rates |
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The rouble has tumbled 22% against the Indian rupee since August 2013; similarly the Ukrainian hryvnia has fallen almost 35% against the Indian rupee. Indian companies have invested into building local manufacturing capacity through joint ventures or on greenfield developments, but these sites are years from completion; currently, the vast majority of Indian medicines sold on the Russian market are imported first. Furthermore, the Russian government mandates fixed prices on its Vital and Essential Drugs List (VED) with recourse for price changes once a year to account for inflation; despite India's position as a low cost manufacturing base, Indian exports to Russia will effectively be discounted in real terms, with negative connotations for profit margins of medicines.
Similarly, pharmaceutical manufacturer associations such as the Federation of Indian Chambers Of Commerce And Industry (FICCI) are concerned about the situation in the Ukrainian economy; almost 30% of Indian trade with the Eastern European country was in pharmaceuticals. With the prospects of Ukraine defaulting and the potential onset of hyperinflation, Indian companies are worried about the landed cost of their goods and whether import demand will dry up in the Ukrainian market.
Owing to the historic ties between Russia and India, Indian companies have aggressively targeted the country and neighbouring CIS markets in Ukraine, Uzbekistan and Kazakhstan to supply generic drugs from a low cost manufacturing base in India. Of all the Indian generic firms, Dr Reddy's Laboratories has the highest exposure to Russia and the CIS markets, with almost INR16.9bn (US$277mn) in sales generated from the region alone; in 2013, this represented almost 14.5% of total global revenues for the company. As a result, we now believe that Dr Reddy's first quarter results will potentially surprise to the downside, and hold a bearish view on the equity.
These developments are on top of sanctions handed down by regulatory agencies in Europe and the US to some of the larger Indian generic players such as Ranbaxy Laboratories and Sun Pharmaceutical Industries over quality control issues and sub-standard manufacturing practices at their Indian sites. The cumulative impact of these developments has fostered negative sentiment around Indian generic pharmaceutical stocks, and we expect that over the coming quarters, there will be further downside risk to their share price.
Medium Term Outlook For Russian Market
Imports of pharmaceuticals will continue to remain elevated in the short term, underpinned by growth in real household consumption spending, but as the provision of healthcare shifts from consumer and onto the state over the medium term, we expect that reliance on imports within the Russian pharmaceutical market will decline as more and more drugmakers invest in local capacity in anticipation of further narrowing of procurement rules and a push from the state to reduce the country's dependence on imported goods.
We previously expected pharmaceutical sales to reach US$50.48bn by 2022, but we now expect sales to fall significantly short of that figure; our forecasts now expect sales of US$42.76bn. The compound annual growth rate (CAGR) in US dollar terms has been revised down considerably in the medium term; whereas previously we expected a five year CAGR of 9.4% in US dollar terms, we now forecast the market to deliver a five-year CAGR of 6.6% to US$33.38bn in 2018.
The Russian pharmaceutical market posted sales of RUB766bn (US$24.30bn) in 2013, growing 11.0% year over year in rouble terms and 9.3% in US dollar terms. Over the next five years, we expect the market to achieve a compound annual growth rate of 9.1% in local currency terms and 6.2% in US dollar terms to a value of RUB1.19trn (US$32.86bn) in 2018.
| Shifting Macroeconomic Fundamentals Impact Long Term Outlook |
| Russian Pharmaceutical Sales, US$bn |
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