Inventory Losses: Ind-Ra in its FY16 Base Metals Outlook has identified Chinese economic growth trajectory as the key sensitivity for metal price performance. China accounts for over 40% of the global consumption of major metals. Given the soft demand scenario in China, base metals prices declined in the range of 2%-21% in the first six months of 2015. On an year to date basis, Chinese domestic hot roll coiled steel prices have declined by 21%, London Metal Exchange (LME) nickel prices by about 12%, LME copper metal prices by 9% and China alumina prices by about 10%. In the last one month, iron ore prices have fallen by 20%, Shanghai steel prices by 16.4%, zinc prices by 7%, copper prices by 5.6% and aluminium prices by 2.9%.
The Indian non-ferrous base metal industry is somewhat oligopolistic and commands a strong physical premium. In the event of a sharp fall in metal prices as well as in metal import from Chinese players, the physical premium is likely to fall, impacting industry margins. If metal prices do not recover in the short term, the industry may incur an inventory loss and a 2%-5% fall in operating profits.
Impact on Steel Sector: India's steel imports from China grew 18.4% yoy FY15 and iron and steels imports rose the most among the top 10 imports from China. While the government increased import duty last month with a lag, it may not be sufficient to increase the competitiveness of Indian steel manufacturers.
Fall in Commodity Prices Unlikely to benefit Manufacturers: Indian manufacturers are struggling with low capacity utilisation. Given the lukewarm domestic demand scenario, the fall in commodity prices is unlikely to benefit the margins of manufacturing units in the short term. They may pass on the benefit to customers in an effort to garner higher volumes. Besides, Indian manufacturers may face increased competitive pressure from Chinese manufacturers.
As observed in the past, China often tries to export its way back to growth. Thus, in the event of a slowdown in China, Chinese producers are likely to increase export quantities and hurt producers elsewhere. Imports from China at lower prices will further affect Indian players' volumes and operating margins.
Impact on Exports: India's exports to China declined 19.6% yoy in FY15 and its share in India's trade stood at 3.86%. While exports to China are not significant, exports to Asian countries account for nearly half (FY15: 49.57%) of India's exports. A sustained slowdown of the Chinese economy would dampen economic activity of other Asian countries since trade linkages of Asian countries with China are fairly high. Indian exports to Asian countries have been sluggish over the last three years (FY15: negative 1.3%, FY14: 1.8%, FY13: negative 0.3%). Exports to Asian countries declined by 17% over January-May 2015.
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Emerging Market Fund Withdrawals May Pressure Rupee: Besides improving fiscal position as well as real interest rate, the strength of rupee was to an extent supported by the foreign investment in country's stock market. A significant portion of the inflow is attributable to Emerging Market Exchange Traded Fund (ETF) whose contribution to Indian markets is usually higher than India dedicated funds. Listed funds globally hold Indian equities worth USD110bn and emerging market funds constitute 64% of this, while the balance is India dedicated funds.
In India, global fund activity turned negative for the first time this year, with outflows worth USD0.3bn in June. The redemptions were mostly attributed to regional funds (emerging markets and Asia excluding Japan) even as India-dedicated fund activity remained positive.
If the turmoil in Chinese market continues, emerging market ETFs may face redemption pressure. This could translate into such funds selling Indian stocks which form part of the ETF basket. If these stock sells are not lapped up by foreign investors through India dedicated funds, there may be some depreciation pressure on the Indian currency.
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