‘One Belt’ infrastructure investments seen as helping to use up some industrial over-capacity

China’s ‘One Belt’ strategy will not be the panacea for the decade-long chronic over-capacity problem of the nation’s basic materials industries, but it is seen an helping to keep production lines rolling

PUBLISHED : Monday, 02 November, 2015, 12:49pm
UPDATED : Monday, 02 November, 2015, 12:57pm

China’s “One-Belt, One-Road” strategy may win its construction and engineering firms many billions of US dollar worth of contracts for decades to come and create demand for building materials, but it will not be the panacea for the decade-long chronic over-capacity problem of the nation’s basic materials industries.

To restore demand and supply balance in the steel, cement and aluminium sectors, where excess capacity has persisted since at least 2004 and amounted to as much as 35 per cent of total capacity, exporting the problem away is not realistic and many years of painful closures of outdated and inefficient plants are unavoidable, analysts said.

“For cement makers, high logistics costs relative to product prices means they have to set up plants overseas instead of meeting overseas demand by exports,” said Lawrence Lu, a senior director of corporate ratings at ratings agency Standard & Poor’s. “For steel makers, also due to logistics costs, exports are only sustainable in the long term for higher value-added products.

“To resolve the problem, uncompetitive production lines need to be shut.”

Beijing’s “One Belt, One Road”[OBOR} trade strategy, initiated by President Xi Jinping two years ago, was “a brilliant plan and will be a lasting legacy” that aims to leverage China’s massive foreign exchange reserves and strength infrastructure construction to improve trade with and exports to the over 60 OBOR nations for mainland industries with over-capacity, CLSA head of China and Hong Kong strategy, said in a report.

Policy bank China Development Bank has doled out US$125.9 billion of loans for 400 projects in OBOR regions by the end of last year, and it had plans to fund 900 projects with US$800 billion of investment, according to a report by ratings agency Fitch.

Low interest rates and generous repayment terms are offered on the condition that mainland firms can be suppliers, builders or operators to these projects.

State-backed commercial banks Bank of China, China Construction Bank and China Citic Bank have also planned a combined US$198 billion of new lending for OBOR projects, Fitch analysts said.

“China’s push for OBOR, with its emphasis on creating demand for large-scale capital-intensive infrastructure investments aboard, aims to relieve, but not resolve, urgent over-capacity pressures and buy time for domestic rebalancing,” they added.

But they said mainland bank’s poor record in allocating resources efficiently raised concerns of wasteful overinvestment, citing a study by the National Development and Reform Commission that found less than 60 per cent of capital projects were delivered as planned since 1997, resulting in 66.9 trillion yuan of “ineffective investment,” of which the bulk were incurred after 2009.

“The question remains whether China’s banks can identify profitable projects and manage risks better than existing financial institutions, including international commercial banks and multilateral lenders with decades of experience in financing emerging market infrastructure,” they wrote.

Even if the mainland institutions have learned their lessons and picked viable projects to back, analysts said OBOR infrastructure projects will unlikely cure the mainland’s over-capacity predicament.

CLSA materials and resources analyst Daniel Meng said while demand for steel, cement and aluminium among OBOR partner nations will be fast-growing for many years to come, the incremental demand for Chinese products will be relatively small compared to output.

“Even if the annual demand growth from OBOR is 20 to 30 per cent, the additional demand may only be 3 to 5 per cent of China’s output,” he told said. “This is because Southeast Asia and Africa’s demand for these materials is only around 15 per cent that of China’s … what’s more, these nations also have their own production.”

China’s steel exports for the first nine months jumped 27 per cent year-on-year to 83.1 million tonnes, with September’s volume surging 32 per cent to a monthly record high.

“China’s steel export in September has already exceeded 15 per cent of domestic production which is very high,” Meng said. “We believe Beijing considers a level of 8 to 12 per cent is more suitable given steel smelting is very energy-intensive and rising exports have already caused trade friction with other nations.”

Similarly, China’s aluminium exports has already reached a scale that prompted complaints from overseas producers. Beijing, and to pre-empt import duties abroad, has slapped export duties on raw aluminium and most of the export is now on processed products, he noted.

On cement, although export opportunities exist, mainland products face keen competition in Southeast Asia from local production by global firms, while Africa’s demand is relatively modest compared to China’s output.

“While export can provide some relief to China’s over-capacity problem, ultimately outdated and inefficient plants need to be closed to fundamentally resolve the problem,” Meng said.

Given ineffective implementation of Beijing’s edicts to cut over-capacity at the local level in the past decade, analysts do not expect rapid progress.

“[Beijing] has been talking about closing capacity for many years, yet total capacity has kept increasing amidst high growth driven by fixed asset investment,” said HSBC’s analysts in a report. “This time, the pressure to reform seems higher than ever … yet we believe none of [the myriad of new measures] will take effect in the short term.”

Analysts at HSBC said they share China Iron and Steel Association deputy secretary-general Li Xinchuang’s view that it will take the mainland at least 10 years to solve the steel sector’s overcapacity problem, since steel mills have cited employment as the key obstacle preventing them from shutting production lines.

“We see no short-cut to developing an effective policy to manage bankruptcies, redundancies, re-training and re-deployment of employees into other industries,” HSBC analysts said.