Saturday, April 12, 2008

The challenge of high steel prices

News reports claim that the Government of India is actively considering a series of measures to contain the rise in steel prices. This follows futile efforts to get the steel companies to voluntarily rein in prices.

Consider this. Steel prices have gone up by over 60% in the past year, with a 25-30% rise in the last three months. Prices of inputs have gone up rapidly over the past year - iron ore has doubled and coking coal trebled. The Governments itself had contributed its share to the recent price rises, with the National Mineral Development Corporation (NMDC) hiking iron ore prices last October. This hike may be taking its full impact now. The stell companies recently raised steel prices by almost 15% by levying a raw material surcharge of Rs 5000.

It is now becoming increasingly clear that the Cabinet Committee on Prices (CCP) will soon announce a package to contain steel prices. The following measures are being proposed
1. Removing the 5% customs duty on imports of steel, pig iron, mild steel, zinc, ferro alloys, and metcoke.
2. Reduction in excise duty from 14% to 8% on pig iron, sponge iron, iron and steel scrap, granules and powder of pig iron, semi-finished products, pencil ingots, bars and rods, angles, shapes, sections and wires.
3. Elimination of the 14% countervailing duty on TMT bars and structurals.
4. Increase in export duty on iron ore to 15% advalorem rate, from the existing Rs 50-Rs 300 per tonne.

Other measures being considered include reversal of railway freight hike, and suspension of futures trading in iron and steel for six months.

I will stick out my neck and argue that all these measures are going to do precious little to contain steel prices rises. They may at best mildly attentuate the price pressures, and that too only in the short-term. The reasons have been extensively discussed in previous posts here and here.

There is another dimension to these regulatory and fiscal measures to ease supply constraints. It is unlikely, even almost certain, that the producers are not going to pass on the lower excise duties to the consumers. Similarly, the lower customs duties are most likely to be captured by the foreign exporters, who are most likely to hike their prices to offset the lower duties. This happened with edible oil imports from East Asia, and will happen with iron products too. Given the relatively small share of exports compared to domestic demand, the higher export duties will achieve little else other than decreasing the competitiveness of our exporters.

A little understanding of tax incidence will help clarify these aforementioned conclusions. Eco 101 teaches us that for products exhibiting inelastic price elasticity of demand, the incidence of tax burden is more on the consumer. If we draw parallels to the present situation, things become clearer. Steel and other metals, facing tight demand conditions in light of a booming economy and buoyant growth in construction and infrastructure sectors, are therefore price inelastic with respect to demand. All fiscal measures are more likely to help producers partially offset higher costs, than benefit the consumers.

The steep rises in raw material and other input prices across the world and the competition arising from a global market place, has placed considerable cost pressures on producers and manufacturers. In this context, they are more likley to keep all tax cuts, and pass on as little as possible to the consumer. The tax cuts therefore end up as corporate welfare, instead of being a relief for the consumers.

The solution to this conundrum has to come from the market itself. Once the prices cross that level when demand starts getting adversely affected, the producers become forced to pass on a greater share of the fiscal concessions to the consumers. The prices of TMT bars had fallen two weeks back as the high prices had started impacting demand. The problem is that there is no way of estimating this threshold price, so as to time Government fiscal interventions accordingly.

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