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Tuesday, Aug 31, 2004

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Will Indian steel go abroad?

Sanjay Bakshi

Any attempt to artificially depress the local price will divert steel to the international market.

YOU have shares that you want to sell. You contact an NSE broker and he tells you that you can sell your shares at Rs 38. You then call your BSE broker and he too tells you that you can sell your shares at Rs 38. Then, suddenly your NSE broker calls to tell you that the situation has changed and now you can sell your shares for only Rs 36. Did the share price fall, you ask? No, he tells you, but insists that if you want to sell your shares, you will get no more than Rs 36.

What will you do? The answer is obvious, is it not? If you still want to sell your shares, you will simply call your BSE broker and sell them at Rs 38. You will also think that your NSE broker has gone crazy.

Now, do the following: In the above hypothetical situation just described, replace "shares" with "steel"; "NSE" with the "local steel market"; "BSE" with the "international steel market"; the "NSE broker" with "the Government", and think that you are an Indian steel company.

The hypothetical situation has becomes real. On August 22, Tata Steel announced its intention to reduce steel prices by Rs 2,000 a tonne, presumably, on pressure from the Government. Other steel companies followed suit, though the price reduction announced by them was less that that of Tata Steel.

On August 23, the prices of steel companies shares fell. Tata Steel's market value declined by 5.6 per cent, Jisco's by 4.8 per cent, and SAIL's by 7.4 per cent. Was this decline rational? A fundamental law of microeconomics states that in the long run you can control the price of a commodity or its supply but you cannot do both. If you fix the price artificially low, the supply will disappear, and if you fix the supply of a commodity, the price will run away.

Remember the licence raj, when the government fixed the supply of most things? The allotment letters of Bajaj Auto scooters became valuable investments.

What happens when market-determined sugar prices rise dramatically? The fixed-price sugar in ration shops disappears. Where does it end up? It ends up getting diverted to the market where prices are determined by the forces of demand and supply, that is, the black market. Before cement prices were de-controlled, one could easily buy cement from the black market at Rs 150 per bag, while there was no availability in shops which fixed the price at Rs 25 per bag.

What happens when you go to watch a popular movie and find that the tickets are sold out. The movie hall is not allowed to charge a higher price and the supply of seats is limited. Fixed price and fixed supply result in the emergence of a black market where tickets are available, but not at the low, fixed, price.

Indian steel is priced at Rs 26,000 per tonne (before the price cuts), while the global average is Rs 30,000 per tonne. Is it not obvious that the only reason why steel prices in India will decline on a sustainable basis will be when international steel prices come down?

This could happen, of course, but until then, any attempt to artificially depress the local steel price will have the natural consequence of diversion of steel by Indian steel companies to the international market, thereby accentuating the problem in India. The Indian steel companies may not say this in public, but their attitude is likely to be no different than that of your rational attitude in the shares example described in the beginning.

One should look at what the steel companies do, not what they say.

(The author is a finance professor at the Management Development Institute, Gurgaon.)

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