ICRA, in its latest research on the steel sector, said that Chinese steelmakers could brace for an extended period of weak domestic demand as the economy goes through the process of rebalancing of an overheated property market, which was a key growth engine driving the country’s steel demand for the last two decades. To prevent the housing market from overheating and to mitigate broader systemic risks to its economy, the Chinese Government introduced the Three Red Lines, which put in place a mechanism to prevent the piling up of excessive borrowings on the balance sheet of property developers.
On September 23, 2021, after struggling to shore-up liquidity for over a year since the rollout of the Three Red Lines, the Chinese Evergrande Group, one of the leading Chinese property developers, missed a US$83.5-million coupon payment on its offshore bond liabilities. Given the investor’s flight to safety, three more Chinese property developers failed to raise capital and defaulted on debt payments in the subsequent month of October 2021.
More recently, on November 6, 2021, fresh concerns about the health of the Chinese property sector resurfaced following the missed payment from another property developer, viz. the Kaisa Group.
Elaborating on this, Jayanta Roy, Senior Vice-President & Group Head, Corporate Sector Ratings, ICRA, said, “The Three Red Lines effectively put in place a check to reign in new housing supply in China. Directly and indirectly, real estate related activities reportedly contribute around 25-30% to the Chinese GDP and around 30% to the Chinese domestic steel demand. Therefore, with the Chinese property sector accounting for around 15% of global steel demand, the ongoing readjustment away from a property driven model of growth in China is likely to have an adverse impact on the steel industry for an extended period. This could signal the start of mean reversion for the commodity, with spreads gradually starting to gravitate towards long-period median levels”.
On the export front, in FY2021, China emerged as the single largest importer of steel from India, reaching a high watermark of over 5 million tonne (mt), supported by the strong demand undercurrents flowing through key steel consuming sectors. However, with the Chinese steel demand growth waning down in the current fiscal, share of steel exports to China by Indian mills have plummeted to just 8% in H1 FY2022 from 30% in FY2021.
This, along with the rising trend in Chinese steel exports, which has increased by 31.3% year-on-year during H1 CY2021, suggests that competition in the export markets between Indian and Chinese mills could intensify going forward. It is noteworthy that this growth is being seen after a gap of five years (CY2016 to CY2020), during which China’s steel exports had declined continuously.
Benefitting from higher vaccination rates and Government fiscal stimulus measures, higher steel demand from rest of the world has temporarily cushioned the impact of lower Chinese demand for now. While China led the first leg of the recovery in global steel markets till the early part of CY2021, going forward, the sustenance of the upcycle in the second leg would hinge on the healthy demand momentum continuing outside of China in ICRA’s opinion.
“Significant downside risks could emerge if the housing crisis turns out to be much deeper than what most people expect, or if the ex-China steel markets become significantly weaker than what it is today. We believe that with China accounting for around 55% of global steel demand, the Evergrande saga may potentially shorten the length of the ongoing steel upcycle going forward, giving us limited visibility beyond FY2023 in the baseline scenario,” Roy added.
That said, in the optimistic scenario, what could give the upcycle more wings to glide beyond FY2023 is an unwavering resolve to achieve carbon-neutrality by China through a sustained period of aggressive supply-side response. This could lead to stricter restrictions on production growth and fresh capacity addition so that the Chinese steel industry can be on track to meet its baseline emission reduction target of achieving peak CO2 emission levels by CY2025 and recording a 30% reduction thereafter by CY2030. This potentially can delay the process of mean reversion due to the steel markets remaining in deficit to meet China’s long-term climate objectives.