The Indian steel industry has $50 billion in debt, 10 times what the steelmakers earned in the last financial year before interest, taxes, depreciation and amortisation, according to Credit Suisse. Meanwhile, prices of Chinese hot-rolled coil, used for buildings and cars, are tumbling toward the $300-a-ton mark, a record low. The 30 per cent jump in China's June net steel exports comes amidst deteriorating profitability and an inventory pileup, according to HSBC.
The industry's desperation is showing. Tata Steel, India's most competitive major producer, has seen its shares fall 44 per cent over the past five years, compared with a 59 per cent rise in the benchmark Sensex. This month, lenders restructured a part of Bhushan Steel's $5 billion debt; last year, the company's managing director was arrested in connection with a bribe-for-loan scandal. Bhushan denied any wrongdoing. Essar Steel, controlled by the billionaire Ruia brothers, is also struggling to repay loans.
Such anxieties were commonplace in the 1990s, too. What saved the bloated industry? The People's Republic joined the World Trade Organisation in 2001, its economy took off, and Chinese steel demand absorbed the excess capacity. This time, though, China won't be a saviour.
If anything, China's slowdown could accelerate, leaving policymakers in Beijing with no option except to throw the monetary taps wide open to revive growth. While Asia would welcome a steadying of Chinese domestic demand, the region would be at risk if monetary easing leads to a sudden depreciation in the yuan. A cheaper Chinese currency would quite literally be a "beggar-thy-neighbour" policy.
The more steel India produces at uncompetitive prices, the bigger the eventual hit to lenders, particularly state-owned banks. So it is in their own interest to cut off life support to producers, eliminating superfluous capacity.
Mistakenly, however, the banks are looking to the government to square the circle. They hope Prime Minister Narendra Modi's government will so massively boost investment in rail, roads and affordable housing that last year's abysmal three per cent growth in domestic steel demand will accelerate quickly to offset the oversupply.
The lenders' gamble suffers from a chicken-and-egg problem: there is little chance of a full-throttled investment revival until banks are healthy; but banks won't be healthy until they dump the bad loans clogging their lending arteries. These loans have financed an inexplicable doubling of domestic steelmaking capacity since 2007 to almost 120 million tons a year.
Even now, more new steel plants are coming online - India could add almost 7 million tons of new steel capacity in the current financial year. This is an awful waste of capital. But the misallocation is not due to equity markets: slumping stock prices quite clearly suggest that shareholders won't finance any new mills. Lenders, however, would rather pretend everything is okay and write new loans, rather than take immediate losses.
The bankers hope the government will shield the over-leveraged steel industry from the heat of Chinese furnaces. Depending on who you ask, the case for protectionism is either watertight or full of holes. Most of the 71 per cent increase in steel imports into India during the last financial year was because of higher Chinese shipments, according to Fitch Ratings.
By increasing import duties, New Delhi can at best keep domestic steel prices near $400 per ton. But even that would not protect the industry: some Indian steel companies pay $250 per ton in borrowing costs alone. As Credit Suisse India strategist Neelkanth Mishra noted recently in the Financial Express
, the overall industry may not be able to pay interest on its debt.
When New Delhi stepped in last month and raised import duty rates by a third on flat steel, exporters of automobiles, washing machines and air conditioners complained. If they have to buy steel at inflated costs when global metal prices are tanking, what chance do they have in world markets, and what hope can there be for Mr Modi's "Make in India" campaign?
Exporters want a rebate on higher steel prices. It's a fair demand, which will nonetheless mean that taxpayers pay twice. They pay a subsidy to manufactured goods exporters so the latter bring in valuable foreign exchange and create jobs; they will pay again when banks finally realise that the zombie steelmakers won't revive, and have to ask their biggest shareholder - the government - for fresh capital.
Unfortunately, the extend-and-pretend game is likely to continue. The government doesn't have the fiscal leeway to give state-run banks the $15 billion in fresh capital that Morgan Stanley believes they urgently need. Indications are that the pitiful budgetary allocation of $1.25 billion for recapitalisation may be raised to $3 billion, and even this may take months.
Time is not on India's side. The steady seven per cent second-quarter GDP growth in China has given policymakers in New Delhi a brief breather. But the extraordinary measures Beijing has had to adopt to stop a brutal sell-off in equities highlight the fragility of the mainland's financial system.
The People's Bank of China recently pledged to keep the yuan at a "reasonable level" and pursue prudent monetary policy. But global investors no longer take assertions of solidity at face value. It's time India, too, starts minding the China risk. There might well come a day when Indian infrastructure investment would lead the global steel industry out of its quagmire. But before reaching for such lofty aspirations, removing the debris of surplus capacity is an urgent priority.
The writer is the Asia economics columnist at Reuters Breakingviews in Singapore. These views are his own