Edelweiss: Steel melting away

Global steel consumption likely to fall in CY09, first time since CY98 Since September, the financial turmoil has spilled into the real economy through tighter credit and general liquidity crunch. In the near term, steel demand has practically stalled across most regions, and industry majors have announced production cuts to balance the market and protect prices. Demand visibility, beyond near term, is now poor.

Steel consumption in CY08 likely to grow just 3%, half of our initial projections Earlier in the year, World Steel Association (erstwhile IISI) had projected consumption/demand growth of 6.4% and 6.0% for CY08 and CY09, Y-o-Y, respectively. Visibility on this kind of growth has, however, dropped sharply. We now expect a growth of just 3.0% in CY08 (more than 50% decline from our initial estimates). In particular, we see China recording negative growth (-10%), Y-o-Y, for Q4CY08. This year, with an anemic 2% production growth (in August) and a shocking 9% decline (in September), Y-o-Y, we believe signs of a slowdown in China are clear.

CY09E global steel consumption set to decline 5% for first time since 1970 In November 2008, International Monetary Fund (IMF) revised its October 2008 forecast and slashed its GDP growth rate forecast to 2.2% for CY09. Since 1996, growth trends in global steel consumption and GDP have remained in sync, and normally one would expect steel consumption to grow in CY09 (in line with growth in global GDP).

However, in CY09, we see this linkage breaking down, and expect global steel consumption to decline 5%, even though global GDP is expected to grow. We believe there are further, downside risks to IMF forecast, as many developed countries could end up showing lower GDP numbers than those estimated by IMF. For instance, IMF forecasts the US and Japan GDP growth at -0.7% and -0.2%, respectively, for CY09. Capital Economics, an independent
macroeconomic research consultancy firm has, however, predicted much larger negative GDP growth numbers for the US (-1.5%), Euro zone (-1.0%), and Japan (-0.2%), for CY09; also, it expects global GDP to grow only 1.5% during the period, lesser than IMF’s forecast. Further, many economists define ‘global recession’ not as negative growth rate for two consecutive quarters, but as less than 3.0% growth. This is because the relatively high growth of developing countries would never let the global GDP growth go negative, even though, for all practical purposes, most of the world may experience effects and issues similar to a recession. With the IMF forecast being slashed to 2.2% from 3.0% earlier, we believe global recession has set in, for all practical purposes.

Past US-led recessions severely impacted steel industries of developed nations We have looked at the impact of US-led recessions on steel production for the top-5 steel producing countries (see table below). The periods represent Great Depression (1929-33) and four other periods of US recession subsequently, viz. 1973-75, 1980-82, 1990-91, 2001- 03. While production in the US, Germany, and Japan declined significantly in such times, developing countries such as China and Korea did not suffer that much. On an average, production decline (Y-o-Y) in the four latest US recessions has been 10.7% in the US and 5.8% in Germany; Japan has shown marginal consumption growth of 1.1%. In developing countries, however, we have seen an average growth of 7-8% in that period.

It must be noted that as a percentage of global production, US’s share has dwindled from 14% in 1980 to ~7% currently, while that of China has risen from 5.2% in 1980 to nearly 36% currently. Other developed countries too show similar picture. Hence, the negative growth in a developed country would now have much lesser impact on the global steel industry, than earlier.

We have grouped countries into four buckets as set-out in the table 2. With recession or recession-like conditions prevailing globally, we expect key developed countries (the US, Japan, Canada, Western Europe) to experience steel consumption decline by 20% in CY09E and another 15% in CY10E. These estimates are much worse than the average decline of 10.7% in the past US-led recessions. We believe, we have adequately covered for a longer and deeper than average US-led recession. In other developed countries (e.g. Bulgaria and Australia), consumption is likely to drop 5% in CY09E and another 4% in CY10E.

In China, we expect consumption growth to stall in CY09, with growth practically nil at 0.8%. This drastic fall is partly due to the exposure of the Chinese economy to the external world, with exports accounting for 54% of the country’s GDP (Source: Bloomberg), and partly due to the slowdown in construction, appliances, and auto sectors (details provided later). However, in CY10E, we expect the Chinese economy to be strong enough to drive ~4.5% growth in steel consumption.

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