PUBLIC SECTOR UNITS

A tale of woes at SAIL

Buffeted by market realities and overstretched on several fronts, the public sector steel behemoth faces an uphill climb back to viability.

SUDHA MAHALINGAM
in New Delhi

THE steel-making giant once considered a jewel in the public sector crown, Steel Authority of India Limited (SAIL), today faces massive haemorrhaging. SAIL, which has the largest workforce among corporate entities in the country, had been a profitable en terprise until recently. However, it suffered a sudden downturn last year and posted losses of Rs. 1,574 crores. In the first quarter of this year, it toted up losses of Rs. 610 crores.

With reports of the government refusing to agree to a financial restructuring proposal and with no other remedy in sight until after the new government takes over, the prognosis is rather grim. If the losses continue, even the infusion of massive doses o f taxpayers' money is unlikely to revive the mammoth undertaking, and this could affect the livelihood of 1.75 lakh employees. Talk of referring the PSU to the Board for Industrial and Financial Reconstruction (BIFR) has set the alarm bells ringing. The irony is that the crisis has come about despite a 5.6 per cent growth in sales last year.

What has caused SAIL's decline and almost imminent fall? How far is the company itself to blame for the current situation and to what extent did factors beyond its control contribute to the process?

That the decline has occurred in the post-liberalisation era which has witnessed rapid capacity creation in the private sector is not entirely coincidental. When the government decided to decontrol steel and open up the sector for private capital in the early part of the decade, steel consumption had appeared to be growing at a promising rate and there was a rush of investments into the sector. The private sector is in the process of adding fresh capacity to the tune of nearly 11 million tonnes by the y ear 2000. Nearly all of this will be in flat products.

Not to be outdone, SAIL also planned a massive modernisation and expansion exercise at a cost of Rs.12,000 crores over the last three years, a process that envisaged adding 1.5 million tonnes to its capacity of flat products. SAIL is already the largest steel producer in the country with a capacity of 12.4 million tonnes of crude steel. It has a capacity of 10.192 million tonnes of saleable steel, 1.184 million tonnes of mild steel, 1.84 lakh tonnes of alloy steel and 1.86 lakh tonnes of hot-rolled carb on steel.

Was this creation of additional capacity in the public and private sector warranted? Demand projections made during the earlier part of the century were rather optimistic and the capacity addition was made based on these projections. However, these proje ctions have been proved wrong. According to a recent paper prepared by the Economic Research Unit of the Joint Plant Committee of the Government of India, domestic demand for finished steel, which is currently around 22.9 million tonnes, is estimated to reach no more than 27.73 million tonnes by 2001-2002. Of the latter, flat products will account for 15.95 million tonnes. According to the paper, even by optimistic estimates the demand will only be 29.6 million tonnes. Projections made by the Ministry o f Steel had envisaged a demand level of 31 million tonnes of finished steel for 2001-2002 and 47.04 million tonnes of finished steel for 2006-2007.

SAIL headquarters in Delhi.

How did the projections go awry? First, they were made on the basis of optimistic gross domestic product growth predictions, which have since been belied. Second, even the 5 per cent GDP growth that has occurred owes itself to an increase in the share of the services sector in national income. In fact, it has been found that the linkages between growth in the primary and secondary sectors and GDP have been weakening. Third, the industrial growth rate hovers around 7 per cent, a much lower level than est imated, resulting in an overall fall in steel consumption. This is mainly because the government, which was the prime provider of infrastructure, has retreated from the sector in the post-liberalisation phase expecting the private sector to step in to th e field. But the private sector has played coy. Fourth, such private investments as there have been in sectors like power, have relied on equipment sourced abroad, and domestic steel-makers have had no part of the pie.

In the case of flat products, which were earlier in short supply and for the manufacture of which substantial additional capacity has been added, the predominant consumer, the automobile industry, prefers to source them from abroad for reasons of quality or other considerations. Maruti Udyog Limited, the market leader in the passenger car sector, imports its requirement of flat steel from Japan. So do most other manufacturers, and this has created a near-crisis situation in the flat products segment. Fi fth, construction activity, which accounts for the largest segment of steel consumption (it consumes nearly a fifth of all steel produced in the country) has been sluggish in the last three years not only in India but in the entire South East Asian regio n. Gross domestic capital formation in the construction field has been much lower than was projected.

Thus, the situation today is that demand predictions have gone awry but ambitious capacity expansion has taken place. How did this happen? Ardhendu Dakshi, former general secretary of the Steel Workers' Federation (SWF), the largest union in the industry , told Frontline: "The World Bank not only encouraged the private sector to set up these huge capacities but even canvassed to find funding for them. The unplanned and irresponsible capacity additions in the private sector have been responsible fo r the state in which SAIL is in today."

The situation has been exacerbated by the growth in imports. Steel imports under the open general licence category were allowed and the duties were brought down from 85 per cent a few years ago to between 20 and 30 per cent now. In fact, hot-rolled (HR) coils used to be imported through advance licences for $225 a tonne until recently, when the government fixed a floor price of $302 a tonne. Steel producers from the Commonwealth of Independent States (CIS) and South Korea have exported flat products to India at prices no Indian producer can match, leave alone SAIL with its enormous wage bills, interest burden and overheads. While some private producers have matched import prices in a desperate attempt to cut down on inventories and losses, SAIL has bee n unable or unwilling to do so. The mechanism to fight the dumping of cheap steel into India is rather weak although Indian producers are often subjected to anti-dumping legislation and punitive measures by foreign steel companies.

While some SAIL plants are in sore need of modernisation, should it have gone in for large-scale modernisation and expansion using borrowed funds? Should it not then have simultaneously revamped its marketing set-up to face the competition? Should it not have pruned costs and made itself competitive even while it was making profits, rather than lock the stables after the horses had bolted?

SAIL has hitherto had a domestic orientation with a virtually captive buyer in the government under controlled market conditions. As a public sector unit and a lumbering giant at that, it not only lacked the agility displayed by its private sector counte rparts but lacked the marketing savvy so essential to succeed in a competitive environment, especially when demand projections have gone awry. Insiders say that revamping the marketing and other departments within the company is easier said than done in an environment where SAIL has been treated as a milch cow by successive parties in power and sundry politicians seeking all kinds of favours including employment opportunities for their near and dear, preference in the award of purchase contracts and so on.

Questions have also been raised as to whether the modernisation and expansion could not have been undertaken at much lower costs than have been incurred. SAIL insiders also say that its modernisation has been sporadic and uneven. Rs. 5,000 crores have be en spent on the Rourkela plant alone. While downstream facilities have been modernised with the installation of hot strip mill/continuous casting facilities, raw material handling has not been modernised. Lack of vision in designing a comprehensive moder nisation programme has resulted in investments which have not yielded commensurate improvements in productivity and quality, they say. While the modernisation measures in Durgapur are satisfactory, Rourkela and Bokaro have not yielded the expected result s, according to knowledgeable sources in SAIL. The modernisation programme was, incidentally, designed by SAIL although it did get consultants to advise it.

The recession combined with over-capacity led to a demand-supply mismatch. SAIL was bound to feel the impact of the mismatch most. The continuing withdrawal of the government from infrastructure development tasks has had a serious impact on SAIL because until recently the government had bought 80 per cent of its steel production.

Following the train accident at Khanna, Punjab, on November 26, 1998, the Railways suspended orders for rails made at SAIL's Bhilai plant which it believed did not meet the requirements. The orders were resumed only in the second quarter of this year aft er ultrasonic and gamma ray tests proved otherwise. SAIL not only lost business in the first quarter, but it also had to invest in new testing equipment. The Railways have been buying around 1.5 million tonnes of rails from SAIL annually.

A paper presented at a seminar on 'The Impact of the New Economic Policy on the Steel Industry in India' organised by the SWF records an all-round fall in the production of saleable steel in all the units of SAIL except the Durgapur unit.

For SAIL, price levels fell even as input costs rose. Increases in railway freight, and the costs of coal and power pushed up the expenditure bill by around Rs. 700 crores a year, prompting SAIL to undertake a massive cost-cutting exercise. However, McKi nsey & Co, the international firm which was consulted by SAIL to recommend measures to achieve a turnaround, reportedly found that SAIL had failed to negotiate effectively with its suppliers to obtain inputs at lower prices even as its output prices were falling. Purchase departments in large PSUs often have entrenched interests, and SAIL is perhaps no exception.

Defective distribution channels have been another problem for SAIL. Under controlled market conditions, steel was first shipped to stockyards in various parts of the country before being sent on to the buyers, which added to the transportation cost. Unde r the freight equalisation policy, SAIL absorbed the additional costs. This policy has since been partially amended but there has been resistance to its scrapping. A multi-tiered system of distribution has led to delays in delivery and higher costs. The Tata Iron and Steel Company (TISCO) has managed to scrap a system that relied on stockyards and cut costs, but SAIL, in typical bureaucratic fashion, has fought shy of revamping the distribution set-up.

There are also historical factors that have aggravated SAIL's woes. Located mainly in the central and eastern parts of the country near coal and iron ore mines, SAIL plants are far removed from the industrialised belt in western India. Private sector sup pliers located closer to this industrial belt have a distinct advantage over SAIL in terms of cost as well as delivery schedules.

While other steel plants have better access to imported coal at rates cheaper than those that prevail in the country, SAIL's options in this regard are rather limited. Notwithstanding improvements in energy-saving and other areas, SAIL can hardly hope to match the lower costs of its overseas competitors given its bloated size. SAIL has a workforce of 1,74,736 lakhs, of which 18,249 are in the executive cadre. Its wage bill is in the region of Rs.2,381 crores for 1998-99. Reports say that some managers w ho have had long tenures have converted their charges into personal fiefdoms and enjoy political patronage which have made them firmly-entrenched. The top management does not always enjoy the freedom to transfer senior executives. A financially attractiv e Voluntary Retirement Scheme (VRS) offer last year was availed of by 3,000 employees, but knowledgable SAIL sources say that the brighter employees were the ones who left.

AT the core of SAIL's current problems is the huge interest burden it has to bear on account of its over-ambitious modernisation programme initiated a few years ago based on demand projections which have since gone awry. The modernisation programme under taken at Durgapur, Rourkela and Bokaro cost the company Rs.12,000 crores, much of which was financed by loans from the Steel Development Fund. Currently, SAIL has a debt equity ratio of 3.03:1 with a total debt of Rs.21,000 crores. The interest burden ha s been mounting. From Rs.808 crores in 1995-96 it rose to Rs.2,017 crores in 1998-99 (including inventory carrying cost). Depreciation amounted to Rs.585 crores in 1995-96, but rose to Rs.795 crores in 1997-98 and to Rs.1,104 crores in 1998-99 thanks to newly capitalised investments in modernisation. SDF loans account for Rs.6,415 crores.

SAIL has submitted a financial restructuring plan to the government, seeking either a waiver of the SDF loan of Rs. 5,000 crores or its conversion into equity. Contributions to the SDF came from SAIL and TISCO in the form of a levy which was neither a ta x nor a cess and the fund was to provide soft loans to steel companies. However, Ispat Industries challenged the proposal even before the government could consider it and the Calcutta High Court restrained the Joint Plant Committee from entertaining SAI L's plea.

A transfer bar being rolled into a coil at the hot-rolling mill of the Salem Steel Plant.

The financial restructuring plan submitted to the government by SAIL also envisages writing down the asset value to the extent of capitalised interest accrued between 1993-94 and 1998-99 along with the writing off of loans and advances, including interes t accrued on it, given by the Government of India to the Indian Iron and Steel Company routed through SAIL. The interest waiver granted to IISCO in the past by SAIL on loans from its own sources, amounting to Rs.506 crores, is sought to be brought back t o SAIL's books of account. All these measures are intended to improve SAIL's debt-equity ratio.

SAIL reportedly hired McKinsey & Co to advise it on a restructuring package for a fee of Rs.8 crores even as its losses mounted. It is learnt that the crux of the McKinsey recommendations is that SAIL confine itself to its core competence, namely, steel- making, and hive off peripheral and ancillary activities. The Steel Executives Federation of India is aggrieved over the recommendations of McKinsey & Co, which they allege lacks the competence to undertake such an exercise.

Persistent efforts by Frontline to secure an appointment to meet with the Chairman and Managing Director (CMD) of SAIL, Arvind Pande, or any senior directors of the company, to elicit their views on various issues, including the McKinsey recommend ations, failed. And Frontline was informed that none other than the CMD was authorised to speak to the press.

According to a note faxed by SAIL officials to Frontline, the company has been scouting for partners to set up joint ventures for its captive power plants at Bokaro, Durgapur and Rourkela, its oxygen plant at Bhilai and its fertilizer plant at Rou rkela. It is on the look out for partners also for the backward integration of the Salem Steel Plant and for the revival of IISCO. These measures are believed to be in line with McKinsey's recommendations. SAIL intends to transfer some of its captive pow er units in its integrated steel plants producing totally 542 MW of electricity and 660 tonnes of steam per hour to a proposed subsidiary company and is seeking a strategic alliance partner to maintain that company for a period of 15 years. SAIL proposes to offer 49 per cent of the equity of this subsidiary, which will continue to supply power to its steel plants, to the alliance partner. SAIL has received expressions of interest from seven companies, of which the Bombay Electric Supply and Transport Un dertaking (BEST) and Enron are shortlisted. However, SAIL has to obtain government approval before it can execute its plans.

McKinsey is also learnt to have advised SAIL to divide its remaining four integrated steel plants into two strategic business units (SBUs), one for flat products, comprising the Bokaro and Rourkela plants and the other for long products, comprising the D urgapur and Bhilai plants.

Arvind Pande, Chairman
and Managing Director, SAIL.

McKinsey has advised SAIL to revamp its Central Marketing Organisation (CMO) in order to save on operating costs, to improve quality and to prune the staff strength by 70,000 in the next five years. A note submitted by SAIL admits that it has targeted th e "right-sizing" of manpower to one lakh people in the next five years. The note claims that its marketing personnel have been empowered to resort to aggressive marketing techniques. It says that SAIL has recently succeeded in securing turnkey orders for mega-projects as well as orders for high-value items. Inventory- reduction, which was another recommendation of McKinsey, is also being attempted. With increase in direct despatches and the establishment of dealer networks, the CMO's stock yard system i s undergoing a change with unviable yards being closed, says the SAIL note.

SAIL also wants to close down its uneconomical units, shops and those facilities that have become redundant as a result of modernisation. The beleaguered company has proposed to reduce subsidies in social infrastructure and turn them into independent pro fit centres.

The 27th annual general body meeting of SAIL held on September 22 reiterated the resolve to prune costs through the implementation of the new proposals.

According to senior Steel Ministry sources, McKinsey has also advised that eventually the flat product SBU be sold to the private sector, followed by the long product SBU. Most of the business and financial restructuring proposals put forward by SAIL are clearly based on the McKinsey report, whose prescriptions leave no one in doubt as to their ultimate objective, namely, to privatise SAIL.