Dragon's drag

China's decision to soft pedal growth could hurt commodity prices

With the Chinese National People's Congress calling for a slowdown in investment to counter overheating in the Chinese economy, what will be the effect on commodity prices?

World over, commodity prices have risen sharply in the past few months mainly on account of surging Chinese demand. Is the party about to end?

In steel, for example, hot-rolled coiled (HRC) prices have crossed $550 a tonne due to insatiable Chinese demand. To take advantage of the current upsurge in the industry, several steel majors have planned capacity expansions "" Tisco is firming up plans to augment its production capacity three fold by 2010 from 4.5 million tonne per annum currently, while JISCO is planning a capacity expansion of 3.5 million tonne and SAIL one million tonne.

Simultaneously, Chinese and international companies are implementing projects to boost steel capacity in China from 257 million tonne in 2003 to 307 million tonne in 2007. India's exports to China are expected to reach 1.25 million tonne in FY04.

But the Chinese Association of Steel Industries has predicted that the latest policy could result in demand growing a mere 7 per cent in 2004-05 compared to 21 percent in the previous year.

And curtailed demand is expected to result in over capacity of 80 million tonne in the Middle Kingdom by the end of 2005. That will force Chinese steel makers to sell their surplus output in overseas markets, which could force HRC prices back to $275-300 a tonne.

The potential negative impact on the Indian steel industry is expected to be offset by a reduction in input costs, as suppliers of key inputs would be forced to adjust to the new market conditions.

As a result, realistic pricing of raw materials should become increasingly likely "" coking coal prices which had jumped four fold to $250 dollar a tonne in the last 12 months, are expected to come down significantly.

Also iron ore prices are expected to retract from a 200 per cent jump witnessed in the last one year. Iron prices are currently hovering at Rs 2300 a tonne.

Apart from lower input costs, the demand for steel within the country which is currently growing at 6 per cent per annum is expected to accelerate to 8 per cent "" this should help steel mills find new customers for their product.

In the case of aluminium, there are growing fears that this metal's price could fall significantly. Chinese aluminium manufacturers in anticipation of a surge in demand in their home markets are ramping up production capacity to 6.5 million tonne from 5.5 million tonne in 2003.

Also capacity expansions are being undertaken by leading players in India. A demand glut is anticipated in the Asian region by early 2006. Aluminium, prices are currently hovering at $1750 a tonne on the LME, up 22 per cent from their levels in May 03.

Analysts fear that Indian companies could see their export prices dipping once again to $1100 a tonne levels within the next two years.

A major beneficiary of a possible downturn in the commodity cycle is the end user industry. Car and 2-wheeler manufacturers have been grappling with a rising supply chain primarily due to steel costs and once these prices are in check, it should help to boost profitability of this industry.

Cris Infac CEO G Ravishankar points out that lower raw material costs are critical both for the passenger car and commercial vehicle industry, because volume growth is likely to be tepid going forward. He expects volume growth in cars to fall to 10 per cent in FY2005.

Commercial vehicle volume growth, too, would fall to 11 per cent. Other industries like housing construction would also benefit from lower steel prices. Lower aluminium prices would help private sector participants to buy drawing rods cheaper, enabling them to set up a transmission and distribution network at a lower cost.

However, this shift in Chinese policy is not anticipated to have an immediate impact on Indian commodity exporters. In short, analysts point out that 15-18 months later when the impact of this policy is felt, it could significantly alter the commodity cycle "" Chinese demand is anticipated to slow down, and with other markets unable to absorb the capacity built up in recent times, the commodity sector would once again face the problem of oversupply.

With contribution by Amriteshwar Mathur