Article for JPC Bulletin 2012

3.25%

Reverse repo rate

7.50%

4.75%

Repo rate

8.50%

3.0%3.5%4.0%4.5%5.0%5.5%6.0%6.5%7.0%7.5%8.0%8.5%9.0%

Feb

27

Mar

19

Apr

20

Apr

24

Jul 2

Jul 2

7

Sep

16,

Nov

2

Jan

25

Mar

17

May

3

May

9

Jun

16

Jul 2

6

Sep

16

Oct

24

2010 2011

Ex-2: RBI's policy rate hikes over last 18 months

Indian Steel Poised For Great Run Despite Current Blip

Despite the temporary setbacks faced by the Indian steel industry in the current fiscal, the long term health remains sound as the Indian economy embarks on a new Five Year Plan, the Twelfth (201213 to 201617), on a far better footing especially the progress made on the infrastructure front. More interestingly, the role of the private sector has greatly enhanced, where private investment has increased from about 24.5% in the 10th Plan to about 36% in the 11th Plan, as development of infrastructure is moving away from government control to publicprivate partnership, with government’s role more of a facilitator/policy maker to aid investment in infrastructure. This big boost from infrastructure/ construction could trigger a substantial amount of steel demand by the end of the 12th Plan, when India’s steel demand is likely to reach about 110 Mmt, i.e., an addition of 8 Mmtpa on an average over the next 5 years.

Indian Economy Under Duress

The Indian economy after growing at a CAGR of 8.6% during 2004‐05 to 2010‐11 (including a respectable 6.8% during the Global Recession of 2008‐09) is now on a sticky patch embattled with slowing GDP growth to 6.9% in Q2 2011‐12 (Ex‐1). To make matters worse the economy is grappled with high inflation, hovering around 9%. As an antidote to inflation the RBI has pursued a tight monetary policy, whereby policy rates have been hiked by 375‐425 basis points over the past 18 months (Ex‐2) to control demand and so anchor inflationary expectations. However RBI’s medicine instead of healing has further exacerbated the economy’s ill‐health by constraining the already tight supply line as higher cost of borrowings made fresh investment unviable, with fixed asset investment growth in the country declining to ‐0.6% in Q2 from 10.3% a year ago. Manufacturing growth has been seriously hampered, down to 2.7% in Q2 from 7.8% a year ago as higher financing costs have also hit consumers hard, private spending growth has slowed down to 4% in Q2 from 6.4% a year ago.

This slump is economic fortunes have had an adverse impact on the both the business and consumer sentiments as such all plans, be it at the corporate level or households are being postponed thereby extending the downturn further. Not only that the national global image has taken a serious beating as foreign institutional investors are now shying away from the country. While FDI flows have softened, foreign institutional investment inflows (both equity and debt) have declined by 80% y‐o‐y to just $7.9 billion in 2011 vs. almost $40 billion in 2010.

As people are pulling money out of the stock markets corporate weariness is rising indicated by drying up of IPOs and also unwilling to inject fresh capacity or increase production. This has had serious ramifications for the heavy industries, particularly steel, where the consumer inertia towards discretionary spending had hit steel demand hard. Also with steel now essentially a buyer’s market, producers are too wary to go ahead with their expansion plans in the current uncertain times.

Dr. Sanjoy Kumar Saha, Senior Economist, Essar Group

Source: CSO

Source: RBI

7.5

9.5 9.69.3

6.8

8.0

8.8

8.4 8.3

7.8 7.7

6.9

Fixed Asset Investment

11.1

-0.6

Manufacturing

10.6

2.7

-1.0

4.0

9.0

14.0

19.0

24.0

5.0

6.0

7.0

8.0

9.0

10.0

2004

-05

2005

-06

2006

-07

2007

-08

2008

-09

2009

-10

2010

-11

2011

-12

Q1 Q2 Q3 Q4 Q1 Q2

Ex-1: Slump in India's GDP Growth

GDP

425 bps

375 bps

1

Does this mean that the positive strides made by the Indian steel industry, where it has risen to become the world’s

4th largest steel producer, would be offset by the current economic scenario and policy inaction? We feel this is just a

blip and the economy would soon turnaround and so would the fortunes of the steel industry.

India’s Fundamentals Remain Strong

The Indian economy is primarily driven by domestic demand as even after 20 years of liberalization exports as a proportion of GDP has risen to about 20% in 2010‐11 from 7% in the early 1990s (in contrast to other Asian economies where exports constitute about 40‐45% of GDP), as bulk of the GDP is generated through private spending and fixed asset investment (Ex‐3). This was reason the Indian economy exhibited amazing resilience amidst the Global Recession of 2008‐09 growing at 8% and 8.5% in the two years after the crisis.

Moreover a positive demographic dividend weighs in India’s favour, where the dependency ratio (non‐working age population – children aged below 15 and old aged people over 64) has been on a steady decline from 69% in 1995 to 56% in 2010 and set to fall further to around 40% for the next 35‐40 years. This has resulted in significant wealth generation in the country, leading to a big rise in average disposable income per year, which has more than doubled over the last 6‐7 years (Ex‐4), seeking higher discretionary spending and so necessitating businesses to expand. It also added more impetus on improvement in physical infrastructure as we witnessed a big rise in fixed asset investment, especially over the last 6‐7 years at a CAGR of 10.3% as against 5.5% in the previous 50 years.

The period of economic liberalization has also ushered in a rapid change in the service industry, which has now become the backbone of economic development in India. However in lieu of declining agricultural growth and saturation in services growth, it is inevitable that industry should take the lead to achieve higher GDP growth on a sustainable basis, a major part of this would be achieved through higher manufacturing contribution and so push India’s GDP growth back to a higher growth terrain. As per the latest Oxford Economic Forecasts (Dec 2011), manufacturing is set to grow at a CAGR of 9.1% over the 12th Plan period, suitably aided by an impressive growth in fixed asset investment (CAGR 11.9%), thus pushing GDP growth close to 9% CAGR over the Plan period (Ex‐5).


84.3% 78.5%73.5% 72.2%

64.9%59.9%

13.8%18.2% 18.7% 21.0% 23.0%

28.7%

5.9% 3.9% 5.5% 6.3% 8.9%18.0%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

1950s 1960s 1970s 1980s 1990s 2000s

% of GDP Ex-3: India eco. primarily domestic driven

Private consumption spending Gross fixed capital formationExports of goods & services

176

681

1,682

14,330

23,005

35,917

0

200

400

600

800

1,000

1,200

1,400

1,600

1,800

1950-51 to 1990-91 1991-92 to 2003-04 2004-05 to 2010-11

41 yrs 13 yrs 7 yrs

Ex-4: Big Jump in India's Purchasing Power

Avg. rise in income per year (Rs)

Per capita income at end of period (Rs)

Source: CSO, In-house

8.7%

9.1%

9.0%

8.5%

11.9%

GDP

Manufacturing

Industrial production

Private spending

Fixed asset investment

Ex-5: India's high growth story to continue in 12th Plan

Source: Oxford Economics

2


CAGR (%) 2012-13 to 2016-17

Sustained Focus on Infrastructure

The fast growth of the economy in recent years has placed increasing stress on physical infrastructure such as electricity, railways, roads, ports, airports, irrigation and water supply and sanitation, both in urban and rural areas, all of which already suffer from a substantial deficit. The importance of investment in infrastructure for achieving a sustainable and inclusive growth of 9‐10% of GDP was duly emphasized for the first time in the 11th Plan, where it was envisaged that investment in physical infrastructure would increase from 5% of GDP during the 10th Plan to about 9% of GDP by 2011–12 (terminal year of the 11th Plan). Although the gross capital formation in infrastructure is likely to rise to about 7.55%, much below the accepted level of 11% as experienced in many other emerging developing countries, yet it constitutes a significant shift in favour of investment in infrastructure. Infrastructure development is now an India priority where the government is acting as a facilitator/policy maker to aid investment in infrastructure.

This thrust on infrastructure investment is set to go up further in the 12th Plan where a preliminary assessment suggests that investment in infrastructure would need to be of the order of about Rs 40 lakh crore (US$ 1025 billion) to achieve a share of 9.95% of GDP over the 12th Plan period (Ex‐6). At least 50% of this investment would have to come from the private sector, which has also witnessed an increase from about 24.5% in the 10th Plan to about 36% in the 11th Plan (Ex‐7), as development of infrastructure is moving away from government control to public‐private partnership.

Construction Upswing Bodes Well For Steel With an increasing focus on infrastructure development, the construction sector has grown leaps and bounds, growing at a CAGR of about 10.6% in the last decade, accounting for over 8% of current GDP (Ex‐8). It is crucial for creating physical infrastructure in the country, as it accounts for more than half of the investment required for setting up critical infrastructure facilities like power projects, ports, railways, roads, bridges etc. With construction activities having strong linkages with various industries, most notably steel, it augurs well for the long‐term health of the industry as nearly half of the planned investment of around $1 trillion in the 12th Plan will be channelized into construction projects.


Source: Planning CommissionSource: Planning Commission


5.71%

7.18%

8.37%

9.50% 10.70%

4.05%4.76% 5.07% 5.00%

5.55%

1.65%2.42%

3.30%

4.50%5.15%

0%

2%

4%

6%

8%

10%

2006

-07

2007

-08

2008

-09

2009

-10

2010

-11

2011

-12

2012

-13

2013

-14

2014

-15

2015

-16

2016

-17

10th Plan

11th Plan 12th Plan

Ex-6: Rising share of infra investment in GDP

Total Public Private

75.5%

69.9%

65.7%

66.3%

65.3%

63.2%

60.6%

63.8%

50%

24.5%

30.1%

34.3%

33.7%

34.7%

36.8%

39.4%

36.2%

50%

10th Plan (actual)

11th Plan (Orginal)

2007-08

2008-09

2009-10

2010-11

2011-12

11th Plan (revised)

12th Plan (projections)

Ex-7: Rising share of pvt investment in infra

Public Private

3.07%4.33% 4.52% 5.08% 5.43%

8.10%

6.32%

5.54% 3.03%4.59%

5.02%

10.60%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

9.0%

10.0%

11.0% Ex-8: Construction on an upswing

Construction as % of GDPConstruction CAGR (%)

3

As infrastructure construction accounts for the maximum share (54%) of construction activities, the potential investment in the construction over the next 5 years would be around 550 billion. Assuming 10% of the spending on steel and an average NSR of US$600/mt, additional steel demand from infrastructure alone could reach about 90 million mt (Mmt) by 2016‐17.

This however should be taken with a pinch of salt as going by the track record of spending in the first 2‐3 years of 11th Plan, actual investment is only about 45‐50% of the planned. While the revised projections in power, irrigation and airport sectors are close to the initial targets, there are significant shortfalls in roads, railways, ports, water supply and sanitation/urban infrastructure. There are huge lags in public investment, most notably in power, ports, telecom and railways, with public investment as per the mid‐term appraisal likely to be 9% lower than initial targets (Ex‐9). Private investment is likely to fare better (Ex‐10), accounting for almost two‐thirds of this increased investment thus offsetting the lags in public investment. The downside however is that private investment is only in selected sectors like power, telecom & airports, with significant lags in roads, ports and urban infrastructure.

A look at the sector‐wise trends of investment, the following points emerge:

Despite private investment in the electricity sector showing an increase of 55% as compared to the original projections, yet capacity addition in the 11th Plan would be 62,374 MW as compared to a target of 78,700 MW.

The projected investment in the road sector is also significantly lower due to a shortfall in the award of road projects by NHAI during the first three years of the Plan. However investments in the road sector are likely to increase during the last two years of the 11th Plan as the Ministry has decided to speed up implementation of the National Highway Development Project (NHDP) to achieve a completion rate of 20 km of highways per day, though the major build‐up in expenditure as a result of this acceleration will be witnessed in the 12th Plan.

As far as the telecom sector is concerned, the growth has been phenomenal with investment expected to be 34% more than anticipated at the time of formulation of the 11th Plan, mainly due to the 60% higher level of investment by the private sector, while investment by the Centre is likely to be 24% lower than the original projections.

Investment in Railways is quite dismal, with both central sector and private investments are below the original projections, with private investment only 16.5% of the original projections.

Similar story is repeated in the port sector, where progress has been much below expectations, with 11th Plan investment now projected to be less than half of the original projection, with private investment in the port sector is also expected to be almost 40% lower as very few PPP projects have been awarded by the respective port trusts in the first two years of the 11th Plan.


Source: Planning CommissionSource: Planning Commission

39.0%

12.3%

-2.8% -8.7% -9.0%-19.6% -22.9% -23.8%

-75.7%-100%

-80%

-60%

-40%

-20%

0%

20%

40%

60%Ex-9: Huge lags in public investment

59.6% 55.0%

19.9%7.1%

-40.3%-57.0%

-83.5% -91.1%-100%-80%-60%-40%-20%

0%20%40%60%80%

Ex-10: Private investment fares better, but only in selected sectors

4

Investment in airports in the 11th Plan has been quite encouraging with projected investment about 17% higher than the original estimate as both public and private investment in airports is likely to increase compared to the investment projected at the beginning of the 11th Plan.

Private sector investment in water supply and sanitation is likely to be below 2% of the total investment in this sector, while public investment would be about 20% lower.

Nevertheless the impetus on infrastructure development would continue and with government more focused on improving the level of implementation, incremental steel demand from infrastructure could reach about 65‐70 Mmt by the end of the 12th Plan. This coupled with positive demographic dividend would be a huge impetus to earnings and will thus generate more discretionary spending on housing, automobiles, consumer durables and capital goods. No doubt passenger car segment is going through a rough patch, but this is a momentary blip and had more to do with RBI rate hikes affecting consumer sentiments. With commercial vehicle segment doing quite well, auto segment would soon turn around, especially as vehicle density in India is quite low vis‐à‐vis other major economies. Similar revival is expected in other steel intensive sectors (Ex‐11). Thus besides infrastructure/ construction, these segments could also trigger a substantial amount of steel demand by the end of the 12th Plan, when India’s steel demand is likely to reach about 110 Mmt, (Ex‐12) i.e., an addition of 40 Mmt in 5 years, an average of 8 Mmtpa.

Huge Steel Investments, Little on Ground

Such high demand potential has elicited huge interest from private steel players to increase their capacities to cater to this demand. Accordingly huge investments had been planned resulting in 10 times increase in steel capex over the last decade. A large number of MoUs has been signed with state governments, especially on the Eastern Coast and also Karnataka (Ex‐13), states renowned for their rich iron ore deposits. Total planned capacity expansion is about 200 Mmt involving an investment of over Rs 6.3 lakh crore, of which 90% involves private players.


Source: Oxford Economics Source: World Steel Association, Oxford Economics, In-house

44.1

69.8

10.5

15.4

5.6

10.3

70

110

0

20

40

60

80

100

120

2011-12 2016-17

(Mmt)Ex-12: Likely steel demand by end of 12th Plan

others

Automobiles

Railways

cons durables

capital goods

Infra/construction

44 4238

31

2022

0

5

10

15

20

25

30

35

40

45

50

16 15 16 15 10 14

KarnatakaJharkhand Orissa BengalChhattisgarhOthers

(Mmt) Ex-13: State-wise proposed steel capacity

5

Source: CMIE

8.0%

8.2%

8.2%

8.2%

8.2%

8.8%

9.6%

12.6%

13.0%

5.0% 7.5% 10.0% 12.5% 15.0%

Electrical equipment

Mechanical machinery

Fabricated products

consumer durables

Railways

others

Infra/construction

Transport equipment

Automobiles

CAGR (%)

Ex-11: Steel intensive sectors set to regain momentum

Most of which are domestic private players with 150 Mmt of planned capacity and another 28 Mmt by foreign private players (Ex‐14). However ground realities are very different as Greenfield steel capacity expansions are seriously constrained and whatever limited capacity enhancements that has taken place are through Brownfield route only. As per information from RBI on the delays in Central Sector steel projects, the cost overrun as a proportion of the original project cost has increased from 19% in 2008‐09 to over 31% in 2010‐11, and is set to go up higher, unless the issues responsible for the delays are acted upon in right earnest, some of which are enumerated as follows:

a. Procedural delays in acquiring clearance for projects ‐ environmental &, forest clearances and similar other regulatory bottlenecks

b. Land acquisition – problems regarding rehabilitation of local people c. Raw material securitization ‐ Shortage of raw materials is one of the major problem areas;

i. Coke needs are met through imports as India does not have large reserves of coking quality coal. ii. Notwithstanding huge domestic availability, high grade iron ore is exported to China. iii. Natural gas is the best alternate fuel/raw material for manufacturing sponge iron/steel. Despite proven reserves of

natural gas there is limited availability to domestic steel users. d. Infrastructure bottlenecks in power, water, roads and port handling capacity e. Delays in allocation of captive mines Such delays in steel capacity expansion have made the domestic industry more dependent on imports, as there has been a complete role reversal; India being a net exporter of steel till 2006‐07 has now become a net importer to the tune of 4.5‐5 Mmtpa, which is likely to swell further as Brownfield expansions would not be enough to meet the rising steel demand in the country.

The Way Forward

A. Improve raw material habits i. As raw material costs of Indian steel constitute about 65% of total costs, we need to improve domestic

availability by curtailing exports and utilize proven domestic reserves ii. Also allocation of captive mines need to be put on a fast track iii. Use new technologies to economize low grade domestic ore iv. Specially designed washeries should be constructed to deal with low volatile coking coal which will contribute

to increased availability of metallurgical coking coal v. All efforts should be made to increase its natural gas availability, like enabling the participation of private sector

in the area of exploration of oil and natural gas

B. A Congenial policy framework i. Create land banks in one specific area ii. Single window clearance for Greenfield projects iii. Set up Steel Development Finance Corporation for easy availability of project finance and also minimize project

backlogs iv. Set up multi‐modal linkages for better logistical support v. Flexible financing options to reduce debt leverage


1928

150

178

020406080

100120140160180200

9 5 72 77

Govt. Pvt. (Foreign) Pvt. (Indian) Pvt. (Total)

Ex-14: Proposed steel capacity by ownership (Mmt)

Source: CMIE

6

Documents

Article for JPC Bulletin 2012