Overcapacity causes concern
By Gong Zhengzheng (China Daily)
Updated: 2004-06-09 08:48

Editor's note: This the third in a series of analytical reports on the current situation of the Chinese economy.

Although overheating investment seems to have cooled down somewhat in the nation's steel sector, concern remains over serious overcapacity.

Jiang Nan, an analyst at CITIC Securities Co, warned that huge overcapacity will be unavoidable, especially among low-grade steel products, if there is a relaxation of efforts to control investment.

Steel production growing between 20 and 25 per cent this year will continue to outpace demand, which is set to increase by 15 to 20 per cent, Jiang predicted.

"Overcapacity in the steel sector will be very severe," Jiang warned, "if steel demand increases by less than 10 per cent this year as a result of the nation's economic fluctuations."

The steel sector, along with cement and aluminium, were listed by the National Development and Reform Commission as overheated industries as early as last August.

The central government is well aware of the fact that the nation's raw material, energy and transport resources cannot support such a rapid growth rate in these sectors.

Many economic policy-making departments, such as the People's Bank of China, are also concerned that the booming real estate sector, which is a major consumer of steel, is also at risk of a supply glut. The bank issued its warning on the state of the real estate market last year.

A bursting of bubbles in the property market would naturally deal a heavy blow to the steel industry. But the steel and property sectors have both responded slowly to these warnings.

Loose land management and speculation were the major causes of the property market's soaring temperature.

In the steel sector, many local investors failed to take heed of the warnings by continuing to launch new steel projects, pushing fixed asset investment growth rate to a mighty 107.2 per cent in 2003.

"The growth of new investment remains very high in the steel sector, although it has slowed down slightly because of government control," said China Iron and Steel Association President Wu Xichun.

New fixed asset investment in the steel sector reached 47.8 billion yuan (US$5.8 billion) during the first four months of this year, a massive year-on-year leap of 99.1 per cent, according to the association's statistics.

This forced the central government to use administrative measures to punish those involved in the launching of a big steel project in East China's Jiangsu Province. The local government also got its hands dirty in this affair, flouting many regulations to assist the construction of the huge plant.

For its part, the China Banking Regulatory Commission has urged banks to restrict new investment and loans to these sectors.

Despite all of these steps being taken, why do investors remain so deaf to the government's warnings?

Money is the simple answer to this question, said China Securities Senior Analyst Qu Li.

"The industry is just so lucrative," explained Qu.

The nation's top 66 steel makers' profits skyrocketed by 116.2 per cent to 28.3 billion yuan (US$3.4 billion) during the first four months of this year.

Jiang said the other important factor resulting in the currently overheated steel sector is inadequate investment from 1996 to 2000 "thanks to underestimates of future steel demand on the domestic market."

Oversupply on the domestic steel market caused consecutive slides in Chinese steel makers' profit from 1996 to 2000.

That round of oversupply was triggered by a business boom in the early 1990s.

But industries like the steel have the tendency to overreact to demandby drastically expanding their production capacity, Qu said.

Prices will plummet when oversupply becomes obvious in the market, which will see the enterprises suffer great losses. In this case, the industry will need much time to absorb the impact, Qu said.

"So I think the government is taking the correct action in restricting investment in the industry," Qu said.

China Iron and Steel Association President Wu added that oversupply was mainly caused by the fragmented state of the industry.

"There are still too many new low-level steel projects," Wu said.

"The production capacity of local steel makers is growing much faster than large and medium-sized ones because of overheating investment," Wu said.

There are 53 companies, each with an annual steel production capacity of 1 million tons or more, and hundreds of smaller or even illegal steel makers in China.

The output of 66 large and medium-sized steel makers - the steel association's members - grew by 18.5 per cent to 69.4 million tons from January to April this year.

While local small-scale companies produced 11.8 million tons of steel during the same period, a year-on-year increase of 89.2 per cent.

Jiang from CITIC Securities called for strict controls to be imposed on investment in small low-level and highly polluting steel production capacity, adding: "At the same time we should continue to support large and medium-sized steel makers' projects for high-value-added products."