Cost Concerns: Price fluctuations in the material market

India’s construction sector witnessed a revival in 2021-22 owing to rising infrastructure investments, a significant decline in Covid-19 cases and pent-up demand. Construction was one of the sectors that was massively impacted by the outbreak of the pandemic. Supply chain disruptions, migration and reverse migration of labour, and hefty increase in construction material cost were major setbacks for the sector. Availability of construction material and price inflation became major issues that have remained even after the pandemic.

India’s construction industry is witnessing a surge in key construction material prices, impeding the progress of work on the ground. Deve­lope­rs and contractors have been left perplexed by this unforeseen inflation. Cement and steel, the fundamental construction materials, have seen an increase in demand and price.

Demand and cost fluctuations in construction material

With the increase in demand for construction material such as cement, steel and aluminium, the prices of these commodities have also been steadily rising over the past few years. This surge in demand and prices have been attributed to the outbreak of the pandemic, which disrupted the entire value chain of these materials. They have also been attributed to the geopolitical issues arising out of the Ru­ssia-Ukraine crisis and the subsequent inc­rease in fuel cost.

Cement is one of the most important materials used in the construction and infrastructure sectors. According to CRISIL, the current growth in cement volume is being driven by demand revival from all segments such as infrastructure, real estate and industrial construction post Covid-19. Cement demand witnessed a growth of nearly 11-13 per cent in 2021-22. As of April 2022, the cost of cement had risen to Rs 390 per bag in the previous 12 months. Meanwhile, as per IIFL Securities, the all-India average cement price increased by Rs 6 per 50 kg bag, or 1.7 per cent on a month-on-month basis, in September 2022. This price increase was witnessed after four consecutive months of price decline. The highest price increase was seen in east India, where the average price increased by 6.6 per cent, followed by the south with a nearly 1.9 per cent increase, and the west with a nearly 1.3 per cent increase. North and central India witnessed flat to marginal declines. On a quarterly basis, the all-India average cement price has decreased by 6.1 per cent (Rs 20 per bag) in the second quarter of 2022-23. The prices in north and central India have decreased by 8.5-9 per cent, and in east India by 5.7 per cent. Me­an­while, prices in the south and west have fallen by 3-4 per cent. The relatively lower decline in the south and east is expected to benefit players such as Dalmia Bha­rat, Ramco Cements and India Cements. The surge in power and fuel costs due to the Russia-Ukraine crisis has raised the cost of road freight, which accounts for nearly 50 per cent of cement transportation.

Another important material used in the construction sector is steel. In 2020, the average price of steel stood at around Rs 35,000 per tonne. Owing to supply chain disruptions and increase in raw material costs, the price of steel increased in the wake of the pandemic and hovered at around Rs 60,000 per tonne in end Dec­em­ber 2021. In March 2022, it escalated fur­th­er to reach Rs 80,500 per tonne. According to Ste­el­­Mint data, the prices of steel started to dec­line from end April 2022 and fell to Rs 60,200 per tonne towards the end of June 2022. The decline continued in July and August and steel prices in mid-September 2022 stood at Rs 57,000 per tonne. Domestic steel prices in India witnessed a decline after continuously increasing over the past two years due to supply disruptions, global decarbonisation measures (especially in China), and the Russia-Ukraine crisis.

Impact of cost escalations

While the lowering of material costs presents a win-win situation to most stakeholders, the inc­rease in prices witnessed since the outbreak of the pandemic has already affected the construction sector, and thereby the infrastructure and real estate sectors, adversely. It has majorly impacted the quality of construction and procurement. It has also impacted the revenues of real estate developers, as they are unable to pass on costs to consumers. This is because the costs for existing projects are fixed in advance, and therefore they have to bear the losses. In most such cases, the qual­ity of construction is compromised in order to reduce losses. The constant rise in the price of building materials has also been detrimental to the construction industry’s ability to deliver projects on time.

According to CRISIL, the budget documents of 19 states indicate a 4.8 per cent increase in state capital expenditure on sectors where cement is a raw material (roads, irrigation and housing). With the rising prices of cement, the overall costs of these projects are expected to increase. However, as per the National High­ways Authority of India, the increase in the pri­ce of raw materials such as cement and steel would not impact road construction as much as it would real estate projects. This is primarily because bitumen is also used in the construction of road projects.

According to Colliers, as of March 2022, the costs of key materials such as cement and steel have risen by over 20 per cent every year. Owing to the increase in the prices of materials such as cement and steel, the average cost of construction for housing projects has risen by 10-12 per cent over the past one year. It is expected that the price may rise by an additio­nal 8-9 per cent by December 2022.

These fluctuations in cost also lead to disputes between the stakeholders, such as the government, contractors and material suppliers. In May 2022, with raw material prices escalating due to the Russia-Ukraine war and Covid-19, contractors in the Malwa zone in Punjab planned to stall work on various government projects, including those under the Pra­dhan Mantri Gram Sadak Yojana.

In sum

According to the Department of Industrial Poli­cy and Promotion, cement production improved by 20.8 per cent in 2021-22, compared to a contraction of 10.8 per cent in 2020-21. The central and southern states are reporting stro­ng developments in housing projects and infrastructure, including irrigation, roads and metros. Despite the increasing production and de­mand, costs have witnessed fluctuations ow­ing to various issues. With the continued geo­poli­tical issues between Russia and Ukraine, ce­me­nt prices are not expected to witness a massive decline in 2022-23.

According to experts, domestic steel prices have decreased owing to the onset of a weak demand season on account of the monsoons and less lucrative exports. Steel prices will, however, continue to remain well above the pre-pandemic levels. According to CRISIL, flat steel prices are expected to increase by 3-5 per cent in 2022-23, after surging by more than 50 per cent in the previous fiscal year.

Going forward, in order to reduce or avoid the risks associated with material price fluctuations, it is essential that contracts are drawn so as to fairly allocate the risk arising due to fluctuations in material price between all parties. For projects that are already under way, the stakeholders involved should engage in dialogue to explore ways to proactively mitigate the impact of commodity price fluctuations or material unavailability, in order to ensure that no single party is overly impacted.

Disha Khanna