On 23 August, B. Muthuraman, managing director of Tata Steel, brought back the flavour of a bygone socialist government era by reducing steel prices by Rs 2,000 a tonne in what he claimed to be an effort to contain inflation. "This is the first time in the history of the steel industry that a company has taken such a step in the larger interest of the nation," he said, flatly denying that the move had anything to do with government pressure.

A more popular view is that Tata Steel can afford this price cut as it has one of the lowest cost structures in the world and is trying to squeeze out competition. Other steel companies like Steel Authority of India (SAIL), Ispat Industries, Essar Steel and Jindal Vijayanagar Steel (JVSL) have been forced to follow Tata Steel's lead with price cuts of Rs 500-Rs 1,000 a ton. The steel industry is only just emerging from the ravages of the downturn and few companies have the capacity to absorb this price cut. The consequent lower margins give them little breathing space since interest outgo continues to be high.

Preliminary calculations by research firm CrisInfac show that the overall impact on the industry would be a 2.5-3 per cent drop in operating margins (See 'The Margin Squeeze'). This, in itself, is not a huge impact at the operating level (profits before interest and taxes are paid), but it could impact the companies at a net profit level because many companies have not been able to reduce their interest outgo. Companies like Ispat Industries and Essar Steel have not made as much headway in reducing their large debt burdens as Jindal Vijayanagar has, for instance.

Even the recent customs duty reduction in scrap from 5 per cent to zero will help Jindal Stainless the most among the integrated players, and not companies like Ispat Industries that do not use the electric arc furnace technology to make steel. In fact, Ispat Industries is still loss-making and the Q1 2004-05 margin for Essar Steel is 26 per cent.

What of the intended impact on inflation? An important point to note is that the price reduction is only for direct domestic OEM users, like the automobile industry, for example.

About 65 per cent of Tata Steel's volumes are sold directly while the rest is sold to the retail trade. This segment stays unaffected since the company says it is not possible to control thousands of retailers across the country to ensure that the price cuts are being passed to the end user. So a householder trying to buy some sheets or rods to build a house will not be paying less.

Therefore, the price cuts will have some impact on the Wholesale Price Index (WPI) that tracks the input costs for industry and takes into account prices of goods like steel and crude oil.

The WPI is now at an all-time high of 7.6. The Consumer Price Index rise has been relatively low since manufacturers have not been able to pass on the rise in input costs entirely to the consumer. Consumer prices have been rising at 3 per cent a year. "In that sense the final consumer stays relatively unaffected," says Mahesh Vyas of the Centre for Monitoring the Indian Economy.