Priorities for Sail

Steel Authority of India (Sail) has announced an expansion plan that will raise its production capacity by two-thirds, or 8 million tonnes of hot metal, in as many years.

It is difficult to figure out how seriously the board has applied its mind before accepting such an ambitious target, since the investment envisaged has not been announced. It could be nothing more than a broad programme, with detailed justifications for specific investments still to follow.

All that has been stated is that initially the capacity expansion will come through de-bottlenecking, financed by internal accruals. But if the free cash generated is used to retire high cost debt so as to lower the debt-equity ratio, and this is a declared aim, then cash to that extent will not be available for capital expenditure.

Budgetary assistance will not be forthcoming and raising new capital will expand the company's already large capital base. The company can certainly go in for capital restructuring and a partial write-off so as to make the balance sheet attractive for raising fresh capital at a premium, that is cheaply, but this is easier said than done in a public sector undertaking.

New capacity looks attractive when there is a global shortage in supply and prices are high. But steel is a notoriously cyclical industry and in a few years' time, after the Beijing Olympics of 2008 is over and the Chinese construction boom has ended, there will once again be a global glut in steel.

It makes sense to expand capacity quickly by going in for de-bottlenecking in the existing plants, but new lines and plants are an altogether different ballgame. In Sail's priorities, the maximum emphasis should be laid on reducing costs of existing operations, improving quality and producing more value added output.

Sail is behind Tata Steel in cost, quality and value addition. Tata Steel can think big, and plan to raise capacity from 4 million tonnes of saleable steel to 7 million and eventually 15 million, because it will have no difficulty selling such large volumes given its cost and quality advantages.

While looking at costs, Sail and the government will have to address the unfinished agenda of divesting non-profitable ancillary plants like those in Salem (stainless steel) and Durgapur (alloy steel), not to speak of Indian Iron (Burnpur).

Some of them may make a profit in boom years but they have no long-term future since they do not measure up to global productivity benchmarks. Indian companies should become global leaders in steel production and meet a major part of the demand arising out of a massive infrastructure upgrade that India can undertake a la China.

But for that they have to first achieve global benchmarks in cost and quality. Otherwise they will not be able to compete against imports, since tariff levels will go down. So it is best not to speak in terms of large capacity expansion without first getting cost and quality right.