Steel: Are capacity additions justified?

Double: That's how much India's top five steel producers plan to increase capacity by over the next five years. SAIL, Tata Steel, JSW Steel, among others, plan to load their balance-sheets with debt and have sold chunks of equity in an effort to open greenfield steel plants and augment capacity at existing plants.

A raft of secondary steel producers, including Bhushan Steel, Visa Steel, JSW Ispat have also embarked on significant capacity additions which will take Indian steel capacity from 78 million tonnes today to over 120 million tonnes over the next four years. This all-in bet by the steel sector begs the question, will India's economic growth justify the massive increase in supply of steel?

Broad set of users

The users of steel fall into two categories: Infrastructure and consumer goods. As a result of having a broad set of users in sectors ranging from rail-roads, real-estate to consumer durables, automobile and machinery, the prospects and performance of steel tend to mimic that of the general economy.

Higher economic growth at between 6.8 per cent and 9.6 per cent since FY06 has seen demand for a variety of steel-intensive products such as real-estate, automobiles, consumer durables grow at double digits. This has pushed up demand for various forms of steel. The per capita consumption of steel is up 66 per cent to 51 kg per head from just half-a-decade ago.

The last five years (since 2005-06) have been strong ones for the Indian steel sector, with the exception of 2008-09 when GDP growth slowed sharply. On a year-to-year basis, steel consumption has grown at a rate higher than the GDP in the good years and decelerated sharply in the bad ones. On a compounded annual basis, steel consumption has risen at an annual rate of 9.5 per cent from 41 million tonnes in 2005-06 to just over 65 million tonnes in 2010-11.

Will market absorb the supplies?

So here in lies the big question for steel producers. With an annual capacity to produce 120 million tonnes of steel to be achieved by 2014-15, that represents an annualised 12.5 per cent growth. However, given that steel consumption has grown at compounded rate of just 9.5 in the last five years, the question is, if the market has the ability to absorb supplies from the new capacities. Any slowdown in GDP growth this year will have a big impact on steel consumption. In that case, the fortunes of the steel sector will be predicated upon an exceptional rebound in the economy next year.

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