Taking the scalpel not the right solution for China’s steel woes
Cutting capacity could have a spillover effect in terms of job losses and more bad debts for lenders, say analysts
Capacity elimination in China’s steel industry may look simple on paper, but in reality could be a painful exercise with huge social and financial ramifications, said industry analysts.
“Some of the “overcapacity” that was eliminated has found its way back after mills resumed production following a marginal recovery in steel prices during the first quarter of this year, ” said Laura Zhai, an analyst with global ratings agency Fitch Ratings.
According to Zhai, the best solution to China’s steel woes is to allow more enterprises to go bankrupt. “But it is not that easy due to the huge financial leverage of the industry and the vast number of people it employs,” she said.
On the ground, however, some mills are already preparing to resume production. Two out of the five furnaces have been warmed up at Songting Steel in Tangshan, north China’s Hebei province with partial production set to resume later this month or in May, sources said. The mill was shut last November by the Hebei government as part of its efforts to reduce capacity in the sector.
Analysts like Zhai feel that nothing much would change for the steel sector in 2016 and 2017.
“That said, there are many in the industry who are expecting fresh guidelines from Beijing on how to identify problematic enterprises and then close them down with the least possible harm, both socially and financially,” she said.
The central government had earlier this year set a target to eliminate 100 million to 150 million tonnes of steel capacity by 2020, after the sector suffered its worst year of price drops and huge overcapacity. It has also set aside a special fund of 100 billion yuan (HK$119.8 billion) to resettle steel and mining industry workers made redundant due to the capacity cuts.
“The fund is far from enough to cover the actually needed settlement allowance,” Zhai said.
Based on the industry productivity norms of 300 tonnes of steel per year per employee in China, the elimination of 150 million tonnes of capacity would mean a loss of around 500,000 jobs in the industry, and potentially more in ancillary industries, according to Fitch estimates.
“This number may not appear large relative to China’s working population, but the steel industry tends to be geographically concentrated in northeast China, north China’s Hebei province, and east China’s Shandong province,” Zhai said.
Layoffs in regions where steelmakers are large employers could lead to spillover effects in related industries such as transportation, power generation, and even retail, she said.
Furthermore, the steel sector has high financial leverage, with the average debt-to-asset ratio at more than 70 per cent. Fitch expects the industry to have total debts of 3-4 trillion yuan, excluding upstream funding through payables and unpaid staff costs.
Out of this debt, nearly one third is in the form of bank loans. Even the shutdown of 100 million tonnes of capacity, a reduction of less than 10 per cent of existing capacity, could significantly hurt the lenders, it said.
Analysts believe that a rapid capacity elimination in the Chinese steel sector is unlikely this year, and this would in turn lead to depressed prices, resulting in higher liquidity and default risks for steelmakers. Most of these firms started expanding rapidly from 2012, mostly with short-term debt.
Dongbei Special Steel, a steelmaker owned by the northeast China’s Liaoning provincial government, failed to repay creditors 852 million yuan in one-year notes and interest in late March, a rare default by a local government-owned company in the interbank bond market. Its chairman was found dead in what was termed as suicide, several days ahead of the default.
Guangxi Non-ferrous Metals, a miner under the Guangxi provincial government, announced it had filed for bankruptcy after owing 14.51 billion yuan to 108 creditors.
Ivan Chung, an analyst with ratings agency Moody’s, said in a note that the recent defaults involve those of the bonds of two provincial government-owned state owned enterprises (SOEs) – Dongbei Special Steel and Guangxi Non-ferrous Metals Group – in the onshore market, had illustrated the limitations on regional local governments’ support for their SOEs.
“Although there is pressure on lenders from the regional governments to maintain credit lines, the two cases cited suggest that such moral suasion may have become less effective, at least in the case of SOEs in industries with overcapacity,” says Chung.
However, there is a vast difference between the failure of a company and one which has to undertake capacity cuts.
Zhai from Fitch said that for companies like Songting Steel, the capacity cuts will have little impact on their overall performance as they have so many other embedded interests.”