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The future is bright but... - Views on News from Equitymaster
 
 
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  • Mar 25, 2000

    The future is bright but...

    The old economy stocks seem to have fallen out of favour. Or so it seems. Consider this. In India, the estimated spending on infrastructure is likely to be Rs 7.6 trillion over the next twenty years. This money will be spent on building roads, bridges, ports, houses and what not. Despite this the money flow in stock markets is distinctly towards the new economy stocks, which are considered to be the new growth engines of the economy. (No doubting that.)

    But step back a moment and think. The new economy companies will also require infrastructure to operate in. And building infrastructure will require steel, cement… Infact India's per capita consumption of steel is 20 kilograms as against 80 kilograms in neighboring China and 925 kilograms in South Korea. This highlights the potential for growth in domestic steel demand over the coming years as per capita income rises and the economy gains pace.

    The domestic steel sector is likely to be a big beneficiary of this infrastructure-spending boom. And companies are eager to meet this demand. Indian steel companies benefit from domestic availability of raw materials (including iron ore) and cheap labour. However, despite these advantages India companies often lose out to foreign competition because of the latter's superior technology and larger volumes, which generate scale and size economies that are unparalleled by Indian companies. And this could prove to be a key area of concern in the future.

    In the years post the Southeast Asian crises (and till recently) global demand suffered considerably. The situation became worse after the Russian crises that contributed to the dramatic increase in surplus steel capacity globally. With large surpluses floating in the market, steel makers resorted to large scale dumping in markets like India. The results were disastrous for the targeted countries. The Indian government had to ultimately resort to import curbs (anti dumping duties) after steel prices declined sharply and the domestic companies started to post decline in profitability if not losses (led of course by the Steel Authority of India). In a sequel to these measures, the government went on impose floor prices on the import of various steel products.

    This recent crisis clearly highlighted the vulnerability of the domestic steel sector. Such events in the future could once again derail growth of the sector. Moreover, the government is bound by its commitments to the World Trade Organisation to bring down import barriers over the next few years. Then the use of tools (such as anti dumping duties) to protect the domestic steel companies would become subject to greater scrutiny.

    Meanwhile, the short-term outlook has once again started to look up. The domestic demand scenario has improved over the last one year (see graph). In recent months international prices too have spurted on the back of a rise in global demand. This has resulted in an improvement in the domestic price scenario. More importantly, this has contributed to the recovery in the steel sector by providing the domestic companies opportunity to export steel (an export led recovery).

    Although the near term picture looks rosy, hurdles in the form of anti dumping duties imposed by countries on imports from India could as yet nip the recovery in the bud. Already the United States, Canada and the European Union are considering or have imposed duties on imports of various steel products from India. A broadening of this measure to include other steel products could deal a deathblow to the domestic steel sector in the medium term.

    The other concern (and the main one) pertains to the government's commitment to step up spending on infrastructure. The need for infrastructure is felt by all. However, given the weak fiscal position, the government is unable to launch a massive public works program. At best this exercise has been regional, which has created further imbalances in the standard of living.

    Nevertheless the long-term scenario for the sector looks bright. The key to dominance in local markets would continue to depend on the willingness of the domestic companies to invest in new technology that will enhance productivity and reduce costs of production.

     

     

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