Curbing China's excess capacity

The success or otherwise of China’s efforts to curtail its excess industrial capacity will have a significant impact on Australia’s economic wellbeing.

China faces three big challenges in the next few years: a slowing real estate sector, growing local debt and the intractable problem of excess capacity. Of the three big challenges, the one that has the most important bearing on Australia is the problem of excess capacity -- in particular in the steel industry.

The Chinese steel industry is not only the largest in the world, it is also the biggest consumer of Australian iron ore -- the country’s largest export earner. Beijing has singled out the steel industry as the one with the most acute problem of excess capacity.

Beijing’s ability to tackle this problem will be one of the most important determinants of the iron ore price and therefore Australia’s budget bottom-line for years to come. The dilemma for Australia is: if the Chinese succeed in curbing excess capacity, it would be good news for the country’s economic rebalancing and future prosperity.

However, if Beijing fails to make headway in this endeavour, Australian miners would be able to enjoy more years of inflated demand. But it will be at the cost of greater economic uncertainty in the country’s largest trading partner, which takes in a third of Australian exports.

First we need to get some perspectives on how bad the problem is. According to the National Bureau of Statistics, the average industrial utilisation rate, which measures excess capacity, was 78 per cent in first half of 2013. It was the lowest point since the fourth quarter of 2009, when Beijing unleashed its 4 trillion yuan stimulus package.

However, there are certain sectors that have lower utilisation rates than the alarming national average of 78 per cent. For example, the utilisation rate for steel was only 72 per cent in 2012; it ranked alongside the plate glass industry as the worst performer when it comes to excess capacity.

Other bad offenders are the cement, aluminium and shipbuilding industries. 2014 will be a particularly important year for culling excess capacity; the Chinese government needs to get rid of 56.3 per cent of excess capacity in the steel industry, 11.4 per cent in cement and 38.9 per cent in plate glass if it wants to achieve its goals under the 12-year plan.

So far, the Chinese government is showing all the signs that it is determined to rein in excess capacity. In early May, the Ministry of Industry and Information Technology, which oversees the steel industry, said the country would need to cut an extra 1.7 million tonnes of steel and 8.5 million tonnes of cement in 2014.

However, Beijing faces two formidable challenges; the slowing economy and the all-important goal of maintaining employment stability.

This is best illustrated through the example of Hebei province, the largest producer of steel in the country. The province is adjacent to Beijing and has contributed heavily to the capital’s sickening smog problem. Hebei has been under tremendous pressure to shut down its polluting industrial capacity to improve Beijing’s environment.

The economic consequence of this environmental crackdown is dire. The provincial GDP almost halved from the same period last year, which was 9.1 per cent. It only expanded 4.2 per cent, which was the second lowest of 31 provinces in the whole country. 

The party secretary of Hebei, Zhou Benshun told Chinese media this week the provinces effort to fulfil the central government’s mandates on excess capacity and environmental standards would hurt its “tendons and bones”.

“The impact will be long-lasting. We need to develop new industries to stabilise economic growth, but new strategic industries cannot be developed overnight,” he said.

The steel industry will be the worst affected. According to the estimates of the Hebei Development and Reform Commission, the key economic planning agency, the province would lose 258 billion yuan ($44 billion) in assets, 55.7 billion yuan ($9.5 billion) in revenues and most importantly 600,000 jobs, directly and indirectly.

One can only imagine the pressure on local officials, who would not be keen to surrender so much tax revenue and bear the heavy responsibility of looking after an army of unemployed. The provincial government needs to fork out an extra 13 billion yuan a year to provide the minimum social security for the unemployed.

The Minister of Industry and Information Technology, Miao Wei, the man who is in charge of implementing the drastic reduction, openly admitted the difficultly of forcing through these changes at a time when the economy is under downward pressure.

The success or otherwise of Beijing’s effort to curb the country’s excessive industrial capacity will have a significant impact on Australia’s future economic wellbeing. This is an area where we need to pay close attention.