India’s steel production appears to be getting affected by inflation and higher interest rates and their effect on demand. India’s crude steel production rose by just 0.3% in May, after declining 1.7% in April, according to the World Steel Association. On a sequential basis, however, steel production in May improved by 2.5%. That may mean that domestic steel companies will report slower steel output in the June quarter.

Note that in the past, large domestic steel makers have reported relatively higher growth, compared with the industry, with the smaller steel plants clocking slower growth. JSW Steel Ltd’s steel production numbers indicate output grew 2% in May after rising 11% in April, but this is largely a base effect; and on a sequential basis, crude steel output gained 3%.

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Though it is early to draw firm conclusions, the data appears to indicate some pressures on output. End-user industries appear to be showing signs of a slowdown too. Maruti Suzuki India Ltd’s domestic vehicle sales rose by just 6% in April-May 2011 from a year earlier. There have been reports about slower consumer durable sales and unsold residential inventory. Firms are hesitating to go ahead with large projects as they are facing cost overruns, finance has become expensive and demand growth is not as rosy as it was. Infrastructure projects, too, are not taking off as expected; and though not a new phenomenon, it adds to the gloom in the outlook. These are some key consuming industries of steel.

Exports are, of course, a way to escape from slower demand, but prices are not as profitable as in the domestic market, and it does not help that the rupee continues to remain firm against the dollar.

While the demand outlook may have bleak undertones, steel firms’ performances will depend more on price realizations of steel and the cost incurred on raw materials such as iron ore and coking coal. China’s domestic steel hot-rolled coil prices have dropped 3% since end-April, but are still 3% higher from the lows they had fallen to in March. Iron ore prices, too, exhibited a similar trend.

While there doesn’t seem to be any concern on prices as yet, a sharp rise in China’s output should be watched. China’s steel production rose around 8% in May, compared with a global growth of 4.2%. In 2010, China’s output had slowed considerably as the government implemented measures to slow growth.

If China’s steel production growth remains high, it could hit prices, unless Chinese consumption of steel, too, increases commensurately, as the nation contributes to nearly 45% of global output. Demand for iron ore and coal will increase sharply, too. If this scenario plays out, it could pose a bigger risk for Indian companies than slower output growth, which can be expected to normalize once inflation and interest rates reverse their increasing trend.

Graphic by Yogesh Kumar/Mint

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