A setback for Tatas

A handout image from October 2006 shows steel slabs being made at Corus' Port Talbot plant in Wales.

At the end of March, Tata Steel, the flagship company of the Tata group, announced that it was closing its steel operations in the United Kingdom that are reportedly bleeding losses at the rate of one million pounds (approximately Rs.9.5 crore) a day. Its board, which met in Mumbai, had rejected a plan to turn the U.K. company around on the grounds that it was unaffordable and did not make sense and preferred a sale of the business. However, with no suitors coming forward to buy out the assets, expectations are that it will soon just shut the British plants. This is the second major failure in investment decisions taken by the Tatas in recent times, the other being the launch of Nano, the cheap, small car.

In Britain, the likely closure has, as expected, raised a series of questions: the fate of the 15,000 workers (more than 4,000 of whom are concentrated in Port Talbot in the south and 3,000 in Scunthorpe in the north) likely to be affected by the decision; the future of the British steel industry given global overcapacity; and the role of competition from and limited protection against, cheap Chinese imports in influencing the current situation. In particular, it is being argued that British industry is being wiped out because Europe and the U.K. protect their industrial sector (against Chinese competition) less than the Americans do. The crisis has also led to a call from the Labour leader Jeremy Corbyn that the U.K. government nationalise the company and not treat workers as expendable, which would require the Conservative Party under Prime Minister David Cameron to rethink its market-oriented industrial policy.

Corbyn’s call makes sense to many because the fate of Tata Steel is widely seen as the result of neglected investment in the company’s plants as it moved from state ownership under British Steel to private owner Corus Steel, before being acquired by Tata Steel in a bidding war against Brazil’s Companhia Siderurgica Nacional (CSN) in 2006. That war took the price paid by Tata for Corus to 608 pence a share from the original offer of 455 pence a share. Analysts, at that time, had held that the final price was clearly over the top, especially for capacities that were not the most competitive, and driven more by “nationalist fervour” rather than business logic. Reflecting that “nationalism”, Ratan Tata was reported as saying at the time: “I believe this will be the first step in showing that Indian industry can in fact step outside the shores of India in an international marketplace and acquit itself as a global player.”

The sceptical analysts are now being proven right. To claim that in 2006 nobody anticipated the 2008 global crisis or the slowdown in China is to miss the point. It is not just that not anticipating is, in itself, a failure. It is also that if the original acquisition costs had been a third lower, Tata Steel might have been in a position to weather the difficulties much better and even stay afloat until the time global capitalism experienced a revival. The Tatas’ claim then was that the decision to acquire Corus at the high price that they did was because of the potential synergies embedded in the acquisition, while their original offer was valid as the price for Corus as a standalone facility.

The claim was that the group could ship iron ore and/or low-cost crude steel to Corus’ plants in Europe, which would use their technological know-how to turn low-cost raw steel into finished products for European markets. Clearly, that did not work.

At that time steel demand was expected to rise sharply on the back of a finance-led construction boom in the region and China’s breathtaking growth. But there were at least some who saw the construction boom as speculative and China’s growth as led by too much investment which created unutilised and unusable infrastructural and industrial capacities.

They were right: the boom went bust and Tata Steel U.K., among the less competitive, faced a crisis.

Ripple effect in India For India, this experience raises a different set of questions. It challenges the much-lauded Indian investment thrust overseas that has been backed by governments unable to ensure adequate demand growth at home. It also raises questions on the ripple effect that the Tata crisis in the U.K. can have within India.

For some time now, Indian firms that have built up adequate capability in certain areas to identify, acquire and run production facilities have been viewing the prospects of expansion abroad owing to the inadequate growth opportunities at home. Besides, large inflows of foreign capital after liberalisation, which were well in excess of the sums required to finance the current account deficit in India’s balance of payments, encouraged the government to liberalise the cap on the investment that domestic firms could make in operations abroad.

The government also incentivised such investment with a concessional tax rate of 15 per cent on dividends Indian companies received from their foreign subsidiaries. As a result, the annual commitments abroad by Indian firms in the form of equity, loan and guarantees issued rose from more than $10 billion in 2007-08, touched an annual figure of about $17-18 billion during 2008-10 and then registered a spike to $40-44 billion during 2009-11 and $35-37 billion during 2012-14.

This did give rise to a new sentiment in government and outside. That the share of manufacturing in GDP at home was distressingly low compared with India’s erstwhile peers when they were at similar levels of per capita income was increasingly ignored. The focus was on the success of Indian firms abroad, not as exporters from India but as investors in foreign lands. Besides Tata Steel, other examples were often quoted, without reference to the possible correctness or otherwise of the investment decision.

The Tatas’ acquisition of JLR Land Rover, Hindalco’s acquisition of Novelis and Bharti Airtel’s acquisition of Zain Telecom’s African operations are typical instances. What the Tata Steel experience reflects is that this kind of strategy, where the focus is on the fortunes of individual Indian (or Indian-origin, as in the case of Arcelor Mittal) companies abroad, has rarely been successful. It has not generated much by way of foreign exchange through profits that are partially repatriated to India with the benefit of lower rates of taxation. It has also been a total failure as an alternative to growth based on investment at home geared to domestic or export markets.

However, the difficulty is that the “nationalist” celebration of the foreign forays of “Indian” firms has encouraged the government to support this strategy. This came into focus in November 2014, during Prime Minister Narendra Modi’s visit to Australia, when the industrialist Gautam Adani signed a memorandum of understanding with State Bank of India for a loan of up to $1 billion. The loan was to part-finance the currently shelved Carmichael project to mine the huge coal reserves in the untapped Galilee Basin. With the Australian federal government and the Queensland State government desperate for the investment to address the problem of collapsing employment in the coal industry, the Adani project too was seen as an instance of India’s emerging role as a favoured international investor that the government had to back.

This, however, is not a new tendency. Even in 2006, when Tata Steel acquired Corus, the Indian government was expected to back the buyout materially, with credit from the public banking system. Reports at the time suggested that the company planned to fund the acquisition on a 53:47 debt-equity basis, with Tata Steel’s exposure likely to be in the region of $4.1 billion, also a mix of debt and equity. This was expected to take Tata Steel’s debt-to-equity ratio above 100 per cent from its pre-acquisition level of about 15 per cent.

So, besides the question of how the company would bear the interest burden, given the high capital costs associated with the competitive bidding, there was the question of where the required credit would come from. When the deal was announced, the then Finance Minister, P. Chidambaram, declared that the government “will be ready to help the Tatas, if they have any request, to complete the Corus transaction”, though he qualified his statement by saying that it would only be “general help” in the nature of facilitating “clearances or approvals or permissions” within the country. But there may have been more to this support.

Tata was to finance its approximately $13 billion acquisition of Corus with around $4.1 billion in equity, $6.14 billion in long-term debt and $2.66 billion in short-term debt. Whatever the final proportions, there can be no doubt that the debt incurred must have been huge (upwards of Rs.12,500 crore at today’s exchange rate). While a consortium of foreign banks led by Credit Suisse, including Deutsche Bank and ABN AMRO, helped put together the package, a number of Indian banks, such as Export Import (Exim) Bank of India, Bank of Baroda, ICICI Bank (U.K.) and Bank of India, had expressed an interest in being a part of the consortium. Given the secrecy surrounding these matters, the exact exposure of these banks is not known.

The debt had been incurred against Corus’ future cash flows that were clearly overestimated. In fact, Tata’s decision to retrench its U.K. assets is seen as a way of paring down the company’s net debt, placed at close to $10 billion (or around Rs.65,000 crore) at the end of last year. But with selling the U.K. assets proving to be a difficult proposition in today’s market, that debt will not be easy to clear. It does increase the vulnerability of the Tatas, since debt of the kind incurred for the Corus acquisition has to be serviced in foreign currency at a time when the rupee is depreciating.

It also increases the vulnerability of an already beleaguered banking system. This has been the result of seeking success abroad rather than fixing problems at home.