Why the early success of China’s supply-side reforms may not last

PUBLISHED : Tuesday, 07 March, 2017, 7:51am
UPDATED : Tuesday, 07 March, 2017, 9:37am

Beijing’s supply-side reforms, introduced a little over a year ago with the aim of eradicating idle capacity in heavy industry, were broadly welcomed as essential to securing China’s long-term growth.

The coal and steel sectors, regarded as the economic backbone of the mainland, have been the major beneficiaries of the leadership’s efforts to retire obsolete capacities and cut excessive stockpiles.

And indeed, the new policy – backed by strict official targets – appears to be yielding the desired results. The prices of steel and coal shot up last year, and companies in both industries reported a marked improvement in performance.

But some analysts doubt the long-term commitment of local authorities to the plan and their ability and willingness to enforce the rules when producers choose to ignore them.

“A stricter mechanism for punishing those disobedient local governments and steelmakers should be established to reinforce the long-term growth of the steel industry,” said GF Securities analyst Li Sha.

Addressing the National People’s Congress on Sunday, Premier Li Keqiang said the government will cut steel production capacity by 50 million tonnes and coal by 150 million tonnes this year. Observers and industry insiders will be listening intently for any further details on the future of Beijing’s supply-side reform policy.

From the outset, the reform measures overseen by President Xi Jinping have been widely seen as a necessary and comprehensive restructuring of the world’s second-largest economy.

China’s 4 trillion yuan infrastructure-focused stimulus package, which ran from 2008 to 2011, had led to lavish spending on public works and consequently a voracious appetite for steel and coal.

Overlapping projects and redundant capacity have since become a major stumbling block for further expansion of the mainland economy.

The excessive capacity and the increasing number of “zombie” firms – perennial loss makers which are technically insolvent – were viewed as an “enemy within” that could catalyse an economic hard landing.

A stricter mechanism for punishing those disobedient local governments and steelmakers should be established to reinforce the long-term growth of the steel industry
Li Sha, analyst, GF Securities

In 2015, members of the China Iron & Steel Association – representing about 100 large steel firms across the country – posted a combined loss of 64.5 billion yuan (US$94 billion), compared to net profits of 22.6 billion yuan in the previous year.

The industry consortium said more than half of the members were mired in losses in 2015 and blamed a slump in steel prices for the woeful performances.

Then, in early February last year, the State Council published plans to cut iron and steel capacity by 100 to 150 million tonnes over the next five years and to slash coal production by 500 million tonnes in three to five years.

The central government set a target for 2016 to cut steel capacity by 45 million tonnes and coal production by 250 million tonnes.

UBS said the full-year goals in both sectors had been almost met by the end of September. By that point, 70.4 per cent of national steel capacity and 63 per cent of coal capacity were being used, UBS said.

Coal output fell to 3.36 billion tonnes last year, down 9.4 per cent from 2015, according to the National Bureau of Statistics, while crude steel output rose 1.2 per cent to 884 million tonnes – an increase that would have been far higher had it not been for the production capacity cuts, according to analysts.

As the slowdown in production outpaced a fall in demand, prices jumped last year.

By November, the benchmark steam coal price at Qinhuangdao, the country’s major coal port, had doubled from a year ago.

Similarly, prices of some steel products such as hot-rolled coils doubled last year, with prices surging to more than 4,000 yuan per tonne in December from about 2,000 yuan a tonne at the beginning of 2016.

However, some local governments, keen to avoid lay-offs and maintain their employment rates, are apparently reluctant to stick to the effort to cut capacity.

A senior official with a state-owned coal company in Jiangsu told the South China Morning Post that coal mines and producers in the province had quietly raised production in late 2016, hoping to cash in on the current elevated prices.

Local authorities have given a tacit approval to do so, said the official, who wished to remain anonymous. It’ll still be a hide-and-seek game between the central and local governments, he said.

He said he and his counterparts will be paying close attention to what officials attending the NPC sessions have to say on the matter.

The mainland authorities are striving to transform the economy into a new growth model driven by consumer spending, rather than investment and exports. As this balance shifts, the government can afford to focus less on fixed-asset investment, which in turn gives it more room to further reduce industrial capacity.

Liu Xuezhi, an economist with Bank of Communications, predicts that buoyant consumer spending will be the main growth engine for the mainland economy this year, jumping 10.2 per cent from a year ago, contributing to 65 per cent of the economic growth.

“The role of consumer spending is increasing fast during the transition of the Chinese economy,” said Liu. “The potential is huge.”