High Interest Rate effect - Steel Industry slowing down

The steel sector seems to be the newest victim of slowing demand. In April, steel consumption grew by just two per cent year-on-year, as against FY12 estimates of 10.7 per cent. From the look of it, things may not be any better in May and June. Monetary tightening is reflecting in demand deceleration. According to a report by HSBC Global Research, at 5.4 mt, steel production was up five per cent on year in April, while real consumption rose just two per cent. Imports too declined 61 per cent to 0.3 mt. Exports, at 0.32 mt, were up 45 per cent. While production is in line with analyst estimates, annualised consumption is lower than expectations. Typically, steel consumption should grow at the long-term multiplier of 1.2-1.5x of the GDP. So with GDP growth estimates of 8.7 per cent, steel consumption should ideally be around 10.7 per cent.
Analysts believe it has been more severe than in the previous cycle, with interest rates rising 200 basis points in 13 months, as against 130 basis points in the previous cycle. This is leading to significant moderation in the GDP and IIP.

The situation looks unlikely to reverse in the near-term. The construction sector in developed markets continues to be weak, almost four years after peaking in 2007. Led by high interest rates and policy-issues, growth rates for industrial capex and construction spending are slowing down in recent months/quarters in India.

While demand for steel here is slower than expected, China’s production of crude steel in April 2011 is at its highest since January 2001 on a daily rate basis . As if slowing demand in India and increased production in China was not bad enough, additional capacity being put up by Essar Steel (3.5mtpa), JSW Steel (3.2 mtpa) and Tata Steel (2.9mt), could put further pressure on domestic steel prices.

Though a large part of incremental capacity will come on stream only in FY13, HSBC Global Research believes Indian steel prices may start trading at a discount to Chinese export prices if this situation (high Chinese exports, low Indian consumption) persists. Data in the coming months will be crucial to gauge where demand is going.