China Downturn Spurs Industry Cutbacks – Analysis

By Michael Lelyveld

After a decade of promises with few results, China is pledging to close thousands of factories, steel mills, and mines to cut the country’s staggering industrial overcapacity.

On Feb. 4, the cabinet-level State Council said it will eliminate 100 million to 150 million metric tons of surplus steel making capacity over the next five years.

The government has made similar promises before, but the latest statement was couched in categorical terms, aimed at a broad range of struggling smokestack industries.

“No new steel projects will be licensed, outdated plants will be closed, and “zombie” companies—those which have ceased operations but have not formally gone bankrupt—eradicated,” the official Xinhua news agency said.

On Feb. 16, eight regulatory agencies including the People’s Bank of China (PBOC) issued a guideline on extending credit to industries for restructuring but threatening that loans to chronic debtors “will be slashed or withdrawn.”

China has been talking about overcapacity in its steel industry since 2004, said Derek Scissors, resident scholar at the American Enterprise Institute in Washington.

But steel makers have opened new plants and production lines even faster than they have closed old ones. The result has added to the glut of steel on world markets, depressed prices, wasted energy, piled up debts, and created more coal-fired smog.

In 2013, the State Council had promised to cut 80 million tons of capacity over a five-year period, including 60 million tons in northern Hebei province alone.

“China should not add any single new steel project for any reason,” Li Xinchuang, head of the China Metallurgical Industry Planning and Research Institute, said at the time.

But since then, China has increased production capacity by about 100 million tons.

Last year, China made 803.8 million tons of crude steel, or 49.5 percent of the world total, according to the World Steel Association.

Xinhua reported on Feb. 4 that China’s production capacity stood at about 1.2 billion tons. The country’s overcapacity of some 400 million tons exceeds the output of the other top five producers—Japan, India, the United States, and Russia —combined.

Better chance of cuts

While the country’s record on reductions is poor, Scissors said the outlook for real capacity cutting may be better this time around.

The difference is that China’s steel production fell 2.3 percent last year as markets weakened at home and abroad.

“All this time when they were talking about cutting production capacity, they never accepted the fact that production was actually going to fall,” said Scissors.

“If they get another production decrease this year, I think they really will cut capacity for the first time,” he said.

The squeeze on steel is just a symptom of industrial problems and economic changes in China as heavy manufacturing fades and the country turns to the service sector for growth.

After years of excessive investment, overcapacity has become an inescapable problem in all of the construction-related industries such as steel, aluminum, cement, and flat glass that were identified as China’s top energy wasters a decade ago.

On Feb. 7, the Ministry of Industry and Information Technology (MIIT) said the government would step up efforts to cut capacity and “strictly enforce environmental standards” in the building materials sector after major producers’ profits slid 6.9 percent to 449 billion yuan (U.S. $68.3 billion) last year.

Cement production fell for the first time in 25 years, down 4.9 percent, as industry profits dropped 58 percent, the ministry said.

Flat glass production dipped 8.6 percent, while profits declined 12.4 percent.

The end of the building boom and the huge oversupply of housing has been blamed for much of the slowdown. Property investment rose just 1 percent last year.

Coal consumption falls

But the overcapacity troubles may weigh most heavily on the coal industry, which is believed to have posted its second year in a row of losses in both production and consumption.

While the government and industry groups have yet to announce 2015 results, reports suggest that coal consumption fell by some 4 percent after dropping 2.9 percent in 2014, the first decline in 14 years.

Coal production was down 2.5 in 2014, the National Bureau of Statistics (NBS) reported. Last year’s decline was likely 2.9 percent, according to a China Academy of Sciences estimate cited by Reuters. A further 4.2 percent drop is expected this year.

The State Council responded on Feb. 5 by pledging not to approve any new coal mines before the end of 2019, state media reported.

On Monday, the National Energy Administration (NEA) said China will shut over 1,000 outdated mines with combined production capacity of 60 million tons this year.

Official statements on the freeze have grown gradually tougher since late December when Nur Bekri, head of the NEA, was quoted as saying that no new mines would be approved for three years “in principle.”

It is unclear whether the policy will leave room for exceptions.

‘Exploration’

On Feb. 1, a guideline issued by the Communist Party of China (CPC) Central Committee and the State Council said that state-owned and private firms would be allowed to explore for coal, oil, and shale gas in the old “revolutionary base” areas of central and western China under a poverty alleviation program.

A Xinhua report on the guideline did not specify when or whether exploration would lead to new coal development.

But a new estimate published with the State Council directive days later suggests the scope of the overcapacity problem.

According to Xinhua, China now has “about 11,000” coal mines with production capacity of 5.7 billion tons per year, nearly 2 billion tons more than estimated production last year.

China’s coal figures are notoriously unreliable. A report in the official English-language China Daily on Jan. 17 citing the State Administration of Work Safety (SAWS) put the number of coal mines at 9,624.

China has closed 7,250 coal mines and eliminated 560 million tons of capacity in the past five years, Xinhua reported. The State Council plans to cut another 500 million tons of capacity in the next three to five years and consolidate an additional 500 million tons under more efficient operators, it said.

Since late 2011, benchmark coal prices have plunged 56 percent to about 370 yuan (U.S. $56.28) per ton, The South China Morning Post reported. The China Coal Industry Association estimates that over 90 percent of operators are running at a loss.

Job losses seen

While the overcapacity problem is a matter of profit and loss for manufacturers, the cutbacks may cost millions of workers their jobs.

On Feb. 4, Xu Shaoshi, minister of the National Development and Reform Commission (NDRC), gave assurances that the downsizing would not lead to massive layoffs as in the late 1990s, when 21 million jobs were eliminated by mergers and consolidations, China Daily said.

The head of the top planning agency argued that conditions have changed since then due to gains in the private sector and greater labor mobility.

But last September, a single coal producer, Heilongjiang Longmay Mining Holding Group, announced plans for 100,000 layoffs in a three-month period.

Xinhua said that iron and steel capacity cuts would cost 400,000 jobs in that sector alone. China International Capital Corp. estimated that the five top overcapacity industries would shed 3 million jobs, China Daily reported.

Workers in coal and other overcapacity industries are unlikely to find other employment due to lack of alternative skills, said Scissors.

“They’re going to pension them out,” he said. “The downside of all this is that these people don’t have any place to go.”

Manufacturers of building materials may be spared the most structural cuts because construction industries may stage a cyclical recovery in time with the return of infrastructure investment, said Scissors.

Coal hit hardest

But the coal industry is likely to suffer the worst of the downturn with permanent closures, driven by economic weakening, environmental pressures and alternative fuels.

“The future for coal in China has to be much less coal capacity,” Scissors said.

“I think coal capacity reduction is going to be more meaningful and sharper, and I think it’s going to cause more dislocation,” he said.

On Friday, high-level economic officials urged faster action on capacity cutting after a meeting in Beijing, but there were also signs of local resistence and concerns about jobs.

Yang Weimin, deputy director of the government’s Central Leading Group for Financial and Economic Affairs said that some local authorities claim to be closing zombie companies but are just revoking unused production licenses, China Daily reported.

The government is still evaluating how many companies and jobs in each industry will be affected by shutdowns, but Yang warned against local overprotection.

“Those responsible for overseeing state assets shouldn’t drag their feet just because shutting down those firms would decrease the amount of assets they oversee, and local governments shouldn’t protect zombie firms,” said Yang, according to The Wall Street Journal.