IndianSteelPoisedForGreatRunDespiteCurrentBlip

DespitethetemporarysetbacksfacedbytheIndiansteelindustryinthecurrentfiscal,thelongtermhealthremainssound 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,whereprivateinvestmenthasincreasedfromabout24.5%inthe10thPlantoabout36%inthe11thPlan,as developmentofinfrastructureismovingawayfromgovernmentcontroltopublicprivatepartnership,withgovernments role more of a facilitator/policy maker to aid investment in infrastructure. This big boost from infrastructure/ constructioncouldtriggerasubstantialamountofsteeldemandbytheendofthe12thPlan,whenIndiassteeldemandis likelytoreachabout110Mmt,i.e.,anadditionof8Mmtpaonanaverageoverthenext5years.

IndianEconomyUnderDuress
The Indian economy after growing at a CAGR of 8.6% during 200405 to 201011 (including a respectable 6.8% during the GlobalRecessionof200809)isnowonastickypatchembattled with slowing GDP growth to 6.9% in Q2 201112 (Ex1). 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 375425 basis points over the past 18 months (Ex2) to control demand and so anchor inflationary expectations. However RBIs medicine instead of healing has furtherexacerbatedtheeconomysillhealthbyconstrainingthe already tight supply line as higher cost of borrowings made fresh investment unviable, with fixed asset investment growth inthecountrydecliningto0.6%inQ2from10.3%ayearago. Manufacturing growth has been seriously hampered, down to 2.7%inQ2from7.8%ayearagoashigherfinancingcostshave also hit consumers hard, private spending growth has slowed downto4%inQ2from6.4%ayearago. Thisslumpiseconomicfortuneshavehadanadverseimpacton 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% yoy to just $7.9 billion in 2011 vs. almost $40 billion in 2010.
Ex-1: Slump in India's GDP Growth
10.0 9.5 9.6 9.3 8.8 Fixed Asset Investment 8.0 7.5 7.0 Manufacturing 6.8 10.6 2.7 4.0 -0.6 5.0 -1.0 6.0 8.0 11.1 6.9 9.0 8.4 8.3 7.8 7.7 14.0 24.0

9.0

GDP

19.0

2004-05

2005-06

2006-07

2007-08

2008-09

2009-10

2010-11

Q1

Q2

Q3

Q4

Q1

2011-12
Q2

Source: CSO

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

9.0% 8.5% 8.0% 7.5% 7.0% 6.5% 6.0% 5.5% 5.0% 4.5% 4.0% 3.5% 3.0% 8.50% 7.50%

Repo rate

375 bps
4.75% Reverse repo rate

425 bps

3.25%

May 3

May 9

Mar 19

Mar 17

Feb 27

Jun 16

2010

Sep 16,

2011

Source: RBI

AspeoplearepullingmoneyoutofthestockmarketscorporatewearinessisrisingindicatedbydryingupofIPOsandalso unwilling to inject fresh capacity or increase production. This has had serious ramifications for the heavy industries, particularlysteel,wheretheconsumerinertiatowardsdiscretionaryspendinghadhitsteeldemandhard.Alsowithsteel nowessentiallyabuyersmarket,producersaretoowarytogoaheadwiththeirexpansionplansinthecurrentuncertain times. Dr.SanjoyKumarSaha,SeniorEconomist,EssarGroup

Sep 16

Apr 20

Apr 24

Jan 25

Oct 24

Jul 2

Jul 27

Jul 26

Nov 2

DoesthismeanthatthepositivestridesmadebytheIndiansteelindustry,whereithasrisentobecometheworlds 4thlargeststeelproducer,wouldbeoffsetbythecurrenteconomicscenarioandpolicyinaction?Wefeelthisisjusta blipandtheeconomywouldsoonturnaroundandsowouldthefortunesofthesteelindustry.

%ofGDP
90% 80% 70% 60% 50% 40% 84.3%

Ex-3: India eco. primarily domestic driven

78.5% 73.5% 72.2% 64.9% 59.9% Private consumption spending Gross fixed capital formation Exports of goods & services 28.7%

IndiasFundamentalsRemainStrong
TheIndianeconomyisprimarilydrivenbydomesticdemand as even after 20 years of liberalization exports as a proportionofGDPhasrisentoabout20%in201011from 7%intheearly1990s(incontrasttootherAsianeconomies where exports constitute about 4045% of GDP), as bulk of the GDP is generated through private spending and fixed asset investment (Ex3). This was reason the Indian economy exhibited amazing resilience amidst the Global Recession of 200809 growing at 8% and 8.5% in the two yearsafterthecrisis. MoreoverapositivedemographicdividendweighsinIndias favour, where the dependency ratio (nonworking age population children aged below 15 and old aged people over64)hasbeenonasteadydeclinefrom69%in1995to 56% in 2010 and set to fall further to around 40% for the next 3540 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 67 years (Ex4), 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 67 years at a CAGR of 10.3%asagainst5.5%intheprevious50years. The period of economic liberalization has also ushered in a rapidchangeintheserviceindustry,whichhasnowbecome thebackboneofeconomicdevelopmentinIndia.Howeverin lieu of declining agricultural growth and saturation in servicesgrowth,itisinevitablethatindustryshouldtakethe leadtoachievehigherGDPgrowthonasustainablebasis,a major part of this would be achieved through higher manufacturingcontributionandsopushIndiasGDPgrowth 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 (CAGR11.9%),thuspushingGDPgrowthcloseto9%CAGR overthePlanperiod(Ex5).
Dr.SanjoyKumarSaha,SeniorEconomist,EssarGroup

30% 18.2% 20% 10% 0% 1950s 1960s 1970s 13.8% 5.9% 3.9% 5.5% 18.7%

21.0%

23.0% 18.0% 8.9%

6.3%

1980s

1990s

2000s

Source: CSO, In-house

1,800 1,600 1,400 1,200 1,000 23,005 800 600 400 200 176 0 1950-51 to 1990-91 41 yrs 1991-92 to 2003-04 13 yrs 2004-05 to 2010-11 7 yrs 14,330 681 1,682

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

Avg. rise in income per year (Rs) Per capita income at end of period (Rs) 35,917

Source: CSO, In-house

CAGR (%) 2012-13 to 2016-17

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

11.9%

Fixed asset investment

Private spending

8.5%

Industrial production

9.0%

Manufacturing

9.1%

GDP

8.7%

Source: Oxford Economics

SustainedFocusonInfrastructure
Thefastgrowthoftheeconomyinrecentyearshasplacedincreasingstressonphysicalinfrastructuresuchaselectricity, 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 910% of GDP was duly emphasized for the first time in the 11th Plan, where it was envisaged that investmentinphysicalinfrastructurewouldincreasefrom5%ofGDPduringthe10thPlantoabout9%ofGDPby201112 (terminalyearofthe11thPlan).Althoughthegrosscapitalformationininfrastructureislikelytorisetoabout7.55%,much belowtheacceptedlevelof11%asexperiencedinmanyotheremergingdevelopingcountries,yetitconstitutesasignificant shiftinfavourofinvestmentininfrastructure.InfrastructuredevelopmentisnowanIndiaprioritywherethegovernmentis actingasafacilitator/policymakertoaidinvestmentininfrastructure. Thisthrustoninfrastructureinvestmentissettogoupfurtherinthe12thPlanwhereapreliminaryassessmentsuggests thatinvestmentininfrastructurewouldneedtobeoftheorderofaboutRs40lakhcrore(US$1025billion) toachievea share of 9.95% of GDP over the 12th Plan period (Ex6). At least 50% of this investment would have to come from the privatesector,whichhasalsowitnessedanincreasefromabout24.5%inthe10thPlantoabout36%inthe11thPlan(Ex7), asdevelopmentofinfrastructureismovingawayfromgovernmentcontroltopublicprivatepartnership.
6% 10% 8.37% 8% 5.71% 4.76% 4.05% 4% 2% 1.65% 0%
2006-07 2007-08 2008-09 2009-10 2010-11 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17

Ex-6: Rising share of infra investment in GDP

9.50% 10.70%

Ex-7: Rising share of pvt investment in infra

12th Plan (projections) 11th Plan (revised) 2011-12 50% 63.8% 60.6% 63.2% 65.3% 66.3% 65.7% 69.9% 75.5% Public Private 50% 36.2% 39.4% 36.8% 34.7% 33.7% 34.3% 30.1% 24.5%

7.18% 5.55%

5.07%

5.00%

2010-11
5.15%

4.50% 3.30% 2.42% Total Public Private

2009-10 2008-09 2007-08 11th Plan (Orginal) 10th Plan (actual)

10th Plan

11th Plan

12th Plan

Source: Planning Commission

Source: Planning Commission

ConstructionUpswingBodesWellForSteel
With an increasing focus on infrastructure development, the constructionsectorhasgrownleapsandbounds,growingata CAGR of about 10.6% in the last decade, accounting for over 8% of current GDP (Ex8). It is crucial for creating physical infrastructureinthecountry,asitaccountsformorethanhalf oftheinvestmentrequiredforsettingupcriticalinfrastructure 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 longtermhealthoftheindustryasnearlyhalfoftheplanned investment of around $1 trillion in the 12th Plan will be channelizedintoconstructionprojects.
Dr.SanjoyKumarSaha,SeniorEconomist,EssarGroup

11.0% 10.0% 9.0% 8.0% 7.0% 6.0% 5.0% 4.0% 3.0% 3.07% 2.0%

Ex-8: Construction on an upswing

Construction as % of GDP Construction CAGR (%) 10.60%

5.02% 4.59% 5.54% 6.32% 4.33% 4.52% 3.03% 5.43% 8.10%

5.08%

Source: CSO, In-house


Asinfrastructureconstructionaccountsforthemaximumshare(54%)ofconstructionactivities,thepotentialinvestmentin theconstructionoverthenext5yearswouldbearound550billion.Assuming10%ofthespendingonsteelandanaverage NSRofUS$600/mt,additionalsteeldemandfrominfrastructurealonecouldreachabout90millionmt(Mmt)by201617. Thishowevershouldbetakenwithapinchofsaltasgoingbythetrackrecordofspendinginthefirst23yearsof11thPlan, actual investment is only about 4550% 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 midterm appraisal likely to be 9% lower than initial targets (Ex9). Private investmentislikelytofarebetter(Ex10),accountingforalmosttwothirdsofthisincreasedinvestmentthusoffsettingthe lagsinpublicinvestment.Thedownsidehoweveristhatprivateinvestmentisonlyinselectedsectorslikepower,telecom& airports,withsignificantlagsinroads,portsandurbaninfrastructure.
60%

Ex-9: Huge lags in public investment

39.0% 40% 20% 0% -20% -40% -60% -80% -100% -75.7% -2.8% -8.7% -9.0% -19.6% -22.9% -23.8% 12.3%

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

80% 60% 40% 20% 0% -20% -40% -60% -80% -100% -40.3% -57.0% -83.5% -91.1% 59.6% 55.0% 19.9% 7.1%

Source: Planning Commission

Source: Planning Commission

Alookatthesectorwisetrendsofinvestment,thefollowingpointsemerge: Despite private investment in the electricity sector showing an increase of 55% as compared to the original projections,yetcapacityadditioninthe11thPlanwouldbe62,374MWascomparedtoatargetof78,700MW. Theprojectedinvestmentintheroadsectorisalsosignificantlylowerduetoashortfallintheawardofroadprojects byNHAIduringthefirstthreeyearsofthePlan.Howeverinvestmentsintheroadsectorarelikelytoincreaseduring the last two years of the 11th Plan as the Ministry has decided to speed up implementation of the National Highway DevelopmentProject(NHDP)toachieveacompletionrateof20kmofhighwaysperday,thoughthemajorbuildupin expenditureasaresultofthisaccelerationwillbewitnessedinthe12thPlan. Asfarasthetelecomsectorisconcerned,thegrowthhasbeenphenomenalwithinvestmentexpectedtobe34%more thananticipatedatthetimeofformulationofthe11thPlan,mainlyduetothe60%higherlevelofinvestmentbythe privatesector,whileinvestmentbytheCentreislikelytobe24%lowerthantheoriginalprojections. Investment in Railways is quite dismal, with both central sector and private investments are below the original projections,withprivateinvestmentonly16.5%oftheoriginalprojections. Similar story is repeated in the port sector, where progress has been much below expectations, with 11th Plan investmentnowprojectedtobelessthanhalfoftheoriginalprojection,withprivateinvestmentintheportsectoris alsoexpectedtobealmost40%lowerasveryfewPPPprojectshavebeenawardedbytherespectiveporttrustsinthe firsttwoyearsofthe11thPlan. Dr.SanjoyKumarSaha,SeniorEconomist,EssarGroup

 Investmentinairportsinthe11thPlanhasbeenquiteencouragingwithprojectedinvestmentabout17%higherthan theoriginalestimateasbothpublicandprivateinvestmentinairportsislikelytoincreasecomparedtotheinvestment projectedatthebeginningofthe11thPlan. Private sector investment in water supply and sanitation is likely to be below 2% of the total investment in this sector,whilepublicinvestmentwouldbeabout20%lower. Neverthelesstheimpetusoninfrastructuredevelopmentwouldcontinueandwithgovernmentmorefocusedonimproving thelevelofimplementation,incrementalsteeldemandfrominfrastructurecouldreachabout6570Mmtbytheendofthe 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 consumersentiments.Withcommercialvehiclesegmentdoingquitewell,autosegmentwouldsoonturnaround,especially asvehicledensityinIndiaisquitelowvisvisothermajor economies.Similarrevivalisexpectedinothersteelintensive sectors(Ex11).Thusbesidesinfrastructure/construction,thesesegmentscouldalsotriggerasubstantialamountofsteel demandbytheendofthe12thPlan,whenIndiassteeldemandislikelytoreachabout110Mmt,(Ex12)i.e.,anadditionof 40Mmtin5years,anaverageof8Mmtpa.
Ex-11: Steel intensive sectors set to regain momentum
Automobiles Transport equipment Infra/construction others Railways consumer durables Fabricated products Mechanical machinery Electrical equipment 5.0% 7.5% 9.6% 13.0% 12.6%

(Mmt)
120 100 80

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

110
10.3

others Automobiles Railways consdurables

8.8% 8.2% 8.2%

70
5.6 10.5

15.4

60

CAGR(%)
8.2% 8.2% 8.0% 10.0% 12.5% 15.0%

40 20 0 2011-12 44.1

69.8

capitalgoods Infra/construction

2016-17

Source: Oxford Economics

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

(Mmt)

Ex-13: State-wise proposed steel capacity

44 42 38 31 22

Huge Steel Investments, Little on Ground

Such high demand potential has elicited huge interest from privatesteelplayerstoincreasetheircapacitiestocatertothis 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 (Ex13), 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%involvesprivateplayers.
Source: CMIE

50 45 40 35 30 25 20 15 10 5 0 16 15 16 15 10 14 KarnatakaJharkhand Orissa BengalChhattisgarhOthers 20

Dr.SanjoyKumarSaha,SeniorEconomist,EssarGroup


Most of which are domestic private players with 150 Mmt of planned capacity and another 28 Mmt by foreign private players (Ex14).HowevergroundrealitiesareverydifferentasGreenfield steel capacity expansions are seriously constrainedand whatever limited capacity enhancements that has taken place are through Brownfieldrouteonly.AsperinformationfromRBIonthedelays inCentralSectorsteelprojects,thecostoverrunasaproportionof the original project cost has increased from 19% in 200809 to over31%in201011,andissettogouphigher,unlesstheissues responsibleforthedelaysareacteduponinrightearnest,someof whichareenumeratedasfollows:
Ex-14: Proposed steel capacity by ownership (Mmt)
200 180 160 140 120 100 80 60 40 20 0

178 150

19

28

9 5 72 77 a. Procedural delays in acquiring clearance for projects Govt. Pvt. (Foreign) Pvt. (Indian) Pvt. (Total) environmental&,forestclearancesandsimilarotherregulatory bottlenecks Source: CMIE b. Landacquisitionproblemsregardingrehabilitationoflocalpeople c. RawmaterialsecuritizationShortageofrawmaterialsisoneofthemajorproblemareas; i. CokeneedsaremetthroughimportsasIndiadoesnothavelargereservesofcokingqualitycoal. ii. Notwithstandinghugedomesticavailability,highgradeironoreisexportedtoChina. iii. Naturalgasisthebestalternatefuel/rawmaterialformanufacturingspongeiron/steel.Despiteprovenreservesof naturalgasthereislimitedavailabilitytodomesticsteelusers. d. Infrastructurebottlenecksinpower,water,roadsandporthandlingcapacity e. Delaysinallocationofcaptivemines Suchdelaysinsteelcapacityexpansionhavemadethedomestic industrymoredependentonimports,astherehas beenacompleterolereversal;Indiabeinganetexporterofsteeltill200607hasnowbecomeanetimportertothe tuneof4.55Mmtpa,whichislikelytoswellfurtherasBrownfieldexpansionswouldnotbeenoughtomeettherising steeldemandinthecountry.

TheWayForward
A. Improverawmaterialhabits
i. As raw material costs of Indian steel constitute about 65% of total costs, we need to improve domestic availabilitybycurtailingexportsandutilizeprovendomesticreserves ii. Alsoallocationofcaptiveminesneedtobeputonafasttrack iii. Usenewtechnologiestoeconomizelowgradedomesticore iv. Speciallydesignedwasheriesshouldbeconstructedtodealwithlowvolatilecokingcoalwhichwillcontribute toincreasedavailabilityofmetallurgicalcokingcoal v. Alleffortsshouldbemadetoincreaseitsnaturalgasavailability,likeenablingtheparticipationofprivatesector intheareaofexplorationofoilandnaturalgas

B. ACongenialpolicyframework
i. Createlandbanksinonespecificarea ii. SinglewindowclearanceforGreenfieldprojects iii. SetupSteelDevelopmentFinanceCorporationforeasyavailabilityofprojectfinanceandalsominimizeproject backlogs iv. Setupmultimodallinkagesforbetterlogisticalsupport v. Flexiblefinancingoptionstoreducedebtleverage

Dr.SanjoyKumarSaha,SeniorEconomist,EssarGroup