According to data from the Insolvency and Bankruptcy Board of India, between 2017 and 2020, financial institutions submitted claims for recovery 4 trillion in defaulted loans by Indian businesses. A high proportion of these belonged to companies in the metals industry, which accounted for more than 45% of all claims filed. Most of these firms in the metal industry are in the iron and steel business. Although India is the second largest steel producer in the world, on an average it is a net importer of steel. India’s imports from China are large enough to make net imports positive. Steel is vital to our ambitions to build infrastructure; Hence there is a need to critically analyze these lapses in the metal sector. This is also because it has policy implications for financial sector and exchange rate policies.
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These defaults were preceded by a prolonged decline in global metal prices, but have not received sufficient attention. This type of deflation in particular sectors has had significant economic consequences throughout economic history. A recent example is the North Atlantic financial crisis, which was driven primarily by a fall in housing prices as it adversely affected the debt repayment ability of those who had borrowed to buy homes. International metal prices (in US dollars) started declining in 2011 and were down 45% by 2016, but domestic prices remained stable due to the large depreciation of the Indian rupee during 2011–14.
In a globalized world, international and domestic prices are related through the law of one price: that is, the domestic price is equal to the product of the exchange rate and the international price. For example, the international value of $1 when the exchange rate is 70 per dollar translates into a price of Rs 70. If the international price halves to $0.5, the exchange rate will have to depreciate. to maintain the domestic price at 140 70. If depreciation is less than this, there will be a fall in domestic prices (deflation). Between 2014 and 2016, declines in global metal prices caused less-than-proportional exchange rate depreciation to lower local metal prices. The Wholesale Price Index for metals followed a similar pattern and declined by about 15% during 2014-16. Global metal prices are dependent on global demand and supply. Data suggests that in the decade starting 2010, excess supply from China that arose due to a weakening global economy played a significant role in bringing down the metal prices.
China is the largest producer of steel and produces about 10 times more than the second largest producer, India. Its share of the global steel market gives it significant pricing power. The unit-level price of products matched by UN Comtrade shows that import prices from China have always been lower than those of the rest of the world, likely driven by differences in quality and cost of Chinese producers. It is important to note that import prices from China declined by 53% during 2011-2016 – more than double the decline in import prices from the rest of the world (a 23% decline). This widening gap between Chinese and rest of the world prices suggests that the decline in global and domestic prices was mainly driven by Chinese steel exporters. This was expected, given the large steel capacity in China, resulting in surplus supply following a slump in global steel demand.
During 2011-16, a large exogenous fall in commodity prices led to an intense price war in the Indian iron and steel market, with the proportion of imports, especially from China, increasing at even lower prices. This is because at low prices, many domestic producers became uncompetitive and Chinese imports took away the market share of domestic firms. Despite our low net imports over the years, net imports from China (as a share of domestic production) increased by 35% during 2011-16. This led to a fall in the wholesale prices of metals. Some of the largest metal sector firms such as Bhushan Power and Steel and Steel Authority of India saw a major decline in sales revenue (during 2014-16, their sales revenue declined by 25% and 17%, respectively) due to the production hit. ), which puts pressure on their operating margins.
We also find that global metal prices and the profitability of firms in the metals sector are highly correlated. As prices began to decline in 2011, the profitability of firms in the metals sector declined and quickly turned negative. Profitability declined further after 2014. Many companies could not cope with this huge shock and defaulted on their borrowings. Profitability declined for all firms but defaulting firms experienced a larger decline.
This establishes a link between the fall in prices and the default, and also brings us to our main point—the fall in global metal prices during 2011-16 resulted in declining profitability for firms and a large number of firms in the sector. I made a mistake.
Normally, one would think that exchange rate depreciation makes domestic firms less competitive in external markets, increases exports, and worsens domestic inflation. But in a globalized world, with the law of one price for tradable goods, exchange rates also affect the competitiveness of firms in the domestic market. If the exchange rate does not depreciate substantially when international prices fall—which usually occurs during periods of weak global demand—this can make domestic firms vulnerable in the domestic market. This is because the price of imported goods will be lower than the price set by domestic firms on the basis of their own costs.
Many firms in the steel sector faced a similar situation during 2014-16, when the depreciation of the Indian rupee was less than the fall in metal prices, and this affected their performance.
This does not mean that the exchange rate should not be managed at all, but it should be borne in mind that depreciation can act as an effective shock absorber, especially at times of reduced global demand and falling global prices. In.
Abhishek Kumar, Rakesh Mohan and Divya Srinivasan are non-resident fellow, chair and distinguished fellow, and research analyst at the Center for Social and Economic Progress, respectively.
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