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Indian steel -- a pampered infant who must grow up

Modi should cut sector aid, liberalize trade and focus support on job-creating industries

| India

Despite the long-standing global glut in steel, Indian producers are relentlessly expanding capacity as if they live in a different world.

Which, in a sense they do. After decades of protection, subsidies and preferential treatment that has insulated Indian steel from international competition, the industry has grown in the bubble of a large and expanding domestic market to which access for foreign rivals is heavily restricted.

They are now responding to the global upsurge in economic nationalism inspired by U.S. President Donald Trump to push the Narendra Modi government to raise import barriers even further.

This must stop. There are much better ways for the Indian government to support economic development than waste scarce resources protecting steel instead of backing other priorities, such as India-wide job generation.

By making steel more expensive than it should be, protection hurts downstream industries that add much more value and could create many more jobs, for instance, automobile and auto components, and construction, the country's top job creator after agriculture and textiles.

Many of these downstream industries are facing slowing demand and rising input costs due to India's steel protectionism. This cuts into their margins in an intensely competitive market place and in turn, reduces their ability to add capacity and employment. This dampens economic growth and thwarts Modi's loudly proclaimed attempt to raise manufacturing's share in gross domestic product.

Moreover, overpriced steel leads to overpriced products which encourage the import of cheaper steel-containing consumer goods from China and elsewhere, discourage the export of value-added finished goods and contribute to India's current-account deficit.

It is time New Delhi changed its definition of a strategic industry. It should be based on a sector's net contribution to adding value in the domestic economy, exports and job creation rather than clinging to an age-old definition of a strategic industry as a basic industry such as steel.

India must use its limited financial resources and policy tools to promote future-oriented industries such as aerospace, semiconductors or artificial intelligence rather than raw material processors.

While other industries such as coal, aluminum and copper are also favored, steel is the country's most pampered sector, has one of the lowest effective taxation after adjusting for a long list of deductions and exemptions. It receives preferential treatment compared to other metals when it comes to protection from imports. Duties on major steel products are higher vis-a-vis nonferrous metals such as aluminum and copper. For example, flat rolled steel products attract a basic import duty of 12.5% compared to flat rolled aluminum products at 7.5% or copper plates and sheets at 5%.

New Delhi also often resorts to highly restrictive tools such as temporary minimum import prices despite strong opposition from downstream industries.

That is not all. Large steel manufacturers have successfully lobbied for the continued imposition of a whopping 30% export duty on high grade (with iron content above 58%) domestic iron ore, the industry's key raw material. That discourages exports and keeps iron ore prices low in India, benefiting steel companies at the cost of iron ore miners.

Thus, Indian steel companies have access to cheaper raw material, a fast growing domestic market protected from import competition along with low effective taxation. Due to this fearsome combination of protective layers, steel producing facilities always sell well in corporate bankruptcy proceedings. So even when companies fail, often because of financial mismanagement, the assets remain in production. Despite the global glut, and capacity reductions in China and elsewhere, the Indian industry keeps growing.

Production of finished steel including alloy and non-alloy steel has risen in the past five years by 23.5% % to 104.98 million tons in FY 2017-18 from 85.05 million tons in FY 2013-14.

India's excessive love of steel echoes the former Soviet Union's obsession with heavy industry at the expense of consumer goods. Indian policy makers think that because steel is a basic input for other industries including capital goods, such as machinery, it needs special nurturing.

But they should realize that if a primary input material is expensive, it will impose cost on much more dynamic downstream industries such as automobiles, construction, consumer appliances, electrical equipment and machinery. That in turn, kills investment and many potential jobs.

International trade liberalization accords should help India address the problem. The government could argue that all sectors must make sacrifices for the beneficial aim of opening the economy. But when it comes to the planned 16-member Regional Comprehensive Economic Partnership (RCEP) -- an Asia-based trade pact accounting for 25% of global GDP, 30% of world trade and 26% of cross-border investment -- Indian steel wants exemptions.

The big steel companies don't want imports from more cost-efficient steel producers such as Chinese or South Korean mills even though that would help India's downstream industries.

Protectionist Indian steel companies are demanding complete exclusion from any tariff reduction commitments under RCEP while conveniently ignoring the fact that India needs the potential benefits of improved access to China, the world's second largest economy after the U.S.

Given India's looming youth crisis -- the inability to find productive employment for more than a million young people joining the labor market each month -- the basic principles of a strategic industry needs rethinking.

A strategic industry should be defined on the basis of its economic multiplier effects on employment, value-added production and exports. A basic raw material or commodity with excess capacity globally should not be considered 'strategic' just because it is basic.

Steel companies stop bleating about assistance and should focus on moving up the value chain where quality and service and not only price wins customers. Japanese and European companies have shown the way. Even if the industry ends up smaller, in terms of production, it can become more valuable, to the owners, the employees and the nation.

The government should focus its limited financial resources -- industrial subsidies and tax breaks -- on future-oriented sectors such as AI and machine learning, high-tech health care, and aerospace. Steel, a pampered infant, should start behaving like an adult.

Ritesh Kumar Singh is chief economist of Indonomics Consulting and.a former assistant director of the Finance Commission of India.

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