DIPLOMATIC ACADEMY OF VIETNAM FACULTY OF INTERNATIONAL ECONOMICS THE CAPACITY CUT IN CHINA’S STEEL INDUSTRY AND POLICY RECOMMENDATIONS Hanoi, 2017 TABLE OF CONTENT 2I Definition of overcapacity and th[.]
DIPLOMATIC ACADEMY OF VIETNAM FACULTY OF INTERNATIONAL ECONOMICS THE CAPACITY CUT IN CHINA’S STEEL INDUSTRY AND POLICY RECOMMENDATIONS Hanoi, 2017 TABLE OF CONTENT I Definition of overcapacity and the overcapacity in the Chinese steel industry: Definition of overcapacity: 2 The overcapacity in the steel industry of China: a Overall of the Chinese steel industry in the 2006 - 2016 period: b The overcapacity in the Chinese steel industry: c Causes of the overcapacity in the steel industry: II Capacity cut measures of the Chinese government in the steel indsutry: III Impacts of the capacity cut: .10 Positive impacts: 10 a Improving environmental conditions: .10 b Easing the real estate bubble: 12 Negative impacts: 13 a Unemployment: 13 b Unpaid debt: 15 c Security and defence: 16 IV Policy recommendations: 17 In the short run: 17 In the long run: 17 REFERENCES 18 I Definition of overcapacity and the overcapacity in the Chinese steel industry: Definition of overcapacity: The term overcapacity is commonly used to describe a situation in which productive capacity is greater than current production Stated simply, overcapacity is capacity unutilized by current production Industrial overcapacity can be measured at the firm, national, and international level, and is the difference between production capacity and actual production, meaning overcapacity is the complementary proportion of the capacity utilization rate To quantify overcapacity, one needs measures of capacity and production Capacity can be measured as nameplate capacity, which is the intended full-load sustained output of a facility Alternatively, it can be measured as “effective capacity,” which is nameplate capacity minus some standard percentage allowed for maintenance and other scheduled downtimes The second part of the overcapacity calculation is a production measure Capacity and production measures allow the calculation of overcapacity, which is the difference between productive capacity and its utilization in current production Overcapacity affects the profitability of companies in the sector because mills cannot produce at economically sustainable levels This is caused by several factors, in which the most common ones are economic situation and overinvestment Cyclical overcapacity is caused by variability in demand When economic downturns occur, factories have more productive capacity than existing demand for a product can support Structural overcapacity is caused by overinvestment in industrial facilities The result of this overinvestment is a rightward shift in the supply curve, whereby more units of a good are supplied than what the market alone would provide 2 The overcapacity in the steel industry of China: a Overall of the Chinese steel industry in the 2006 - 2016 period: From the map, it can be seen that most of the steel production is concentrated in the Northest, including cities and provinces: Liaoning, Beijing, Hebei, Shandong and Jiangsu Distribution of steel production in China by province, 2015 In the last 25 years, China's steel output had increased more than 12 times Meanwhile, European Union (EU) steel output fell by 12%, while that of the United States remained the same China's steel output from 1990 to the present is as follows: 1990 - 66.4 million tons, 2000 - 128.5 million tons, 2010 - 638.7 million tons, increased to 822.7 million tons in 2014 and reached 803.83 million tonnes in 2016 In 2017, the steel output is expected to continue to rise as the Government has enhance the infrastructure buidling to prepare for the 19 th National Congress of the Communist Party of China Source: World Steel Association However, the domestic demand has always been lower than the supply As shown in the chart below, although the steel demand in China increased very significantly over years due to the rapid economic growth, it has never been equal to the production output The gap between quantity demanded and quantity supplied stood at around 85 million of metric tons, which is equal to the total production output of Japan, the second-largest steel producer in the world China's expected steel demand in 2016 even dropped to only 672 million tonnes, much lower than the domestic output Steel demand in China, 2008 - 2015 Source: Marketrealist For that reason, Chinese manufactures had to enhance the steel export and lower the price to deal with the large amount of products which can not be sold 46% of the world's 725 million tons of excess steel is located in China, according to a report by the Alliance for American Manufacturing Association (AAM) The country's steel exports have doubled since 2012 to 108 million tonnes, or 23% of the world's trade volume As a result, cheap Chinese steel has flooded the world, which put steel mills in other countries into a crisis caused by the inability to compete with Chinese steel1 AAM (2016), Steel and the US Economy, http://aamweb.s3.amazonaws.com/uploads/resources/projectgreenwood_factsheet_steelfacts_11.2.pdf; Báo Giao thông (2016), Ngành thép Trung Quốc tự bắn vào chân mình, http://www.baogiaothong.vn/nganh-thep-trung-quoc-dang-tu-ban-vao-chan-minh-d149845.html According to World Steel Association (WSA), China's steel industry is surging in volume However, it comes with a large amount of redundant products This has been a result of overcapacity within the industry The excess capacity in the steel sector have increased significantly over the years, leading to the remarkable drop in prices b The overcapacity in the Chinese steel industry: Chinese steel industry has been facing serious overcapacity situation, as shown in the chart below Overcapacity in the steel industry of China, 2000 - 2015 Source: Center on Globalization, Governance & Competitiveness, Duke University US Department of Commerce (2017), Steel export report: China, https://www.trade.gov/steel/countries/pdfs/2016/annual/exports-china.pdf The chart shows the overcapacity in the Chinese steel industry from 2000 to 2015 It can be seen that the excess capacity has risen sharply over the year and reached nearly 350 million metric tons in 2015 Meanwhile, the steel production output of this country stood at lower than 800 million metric tons in the same year Therefore, if Chinese steelmakers want to achieved their optimistic production costs, they have to increase the output by nearly a half in the coming years However, given that the steel industry of China has already been saturated with a lot of inventories and redundant products, raising the output will only exacerbate the problem and put the Chinese economy into an overproduction (or capitalist) crisis That is not to mention a lot of criticism that China has received from the international community and global manufactures due to the remarkable increase in output in recent years, as it led to the drop in Chinese steel prices and the inability to fairly compete of other countries’ steelmakers Furthermore, Chinese steel producers themselves, including many state-owned ones, have also suffer from this matter, as cheap prices caused serious losses, but if they stop the production, the consequences would be much more severe (losing market shares, higher opportunity costs, ) Therefore, in that situation, cutting the steel capacity appeared as the best choice for the Chinese government, although it comes with a lot of socio-economic problems From that, the output is also expected to reduce in order to deal with the criticism from US and European governments and steel producers c Causes of the overcapacity in the steel industry: - Economic downturn: As the global and Chinese economy showed downward trend in recent years, the demand for steel also decreased sharply As a result, factories cannot produce with their most effective capacity due to the fear of redundant products and inventories, which led to the serious situation of overcapacity - Overinvestment: Overinvestment in the most recent era has been created by China’s “state capitalism” model, which designates “pillar” and “strategic” industries for special growth targets and financial incentives that are received largely independent of market conditions In particular, overcapacity in China’s steel sector is caused by subsidized energy and other inputs, access to cheap finance, and national versus subnational government dynamics, notably the financial and tax incentives of provincial and local government to increase steelmaking capacity independent of market prices and the mandates of China’s central government II.Capacity cut measures of the Chinese government in the steel indsutry: In February 2016, the Chinese government revealed its ambitious restructuring plans for the country’s steel industry, aimed at tackling overcapacity and boosting efficiency of the sector The government plans to remove 100-150 million tonnes of steel capacity and 800 million tonnes of outdated coal capacity by 2020 The restructuring plan appears to have been well followed through so far as it was announced at the 12th National People’s Congress annual meeting that China, in 2016, successfully cut steel capacity by more than 65 million tonnes and coal production capacity by 290 million tonnes, surpassing the target of 45 million tonnes and 250 million tonnes, respectively 13th Five-Year Plan targets of China’s steel sector For the share of China’s 10 biggest steel producers to reach 60% of the country’s total (compared to 35% in 2015), a series of mergers and acquisitions (M&As) is expected in the steel industry For a start, Baoshan Iron & Steel has merged with Wuhan Iron & Steel, creating China’s largest and the world’s secondbiggest steel mill in terms of combined crude steel production (61 million tonnes in 2015) About 10 million tonnes of outdated steel capacity has been removed in the process and total of 15.4 million tonnes will be cut by 2017 The consolidation is expected to increase competitiveness, especially in value-added sectors such as the automobile market, and improve profitability through cost savings Despite the outstanding results, China’s crude steel output showed growth to 808.3 million tonnes (equivalent to the 0.6% increase) in 2016 This is because a large proportion of closed capacity had actually already been left idle for years In 2017, China plans to cut another 50 million tonnes of steel-making capacity, shut down coal output by 150 million tonnes, and, at the same time, close or stop construction of coal-fired power plants with capacity of more than 50 million kilowatts in 2017 Not included in this capacity-reduction target is the closure of intermidiate frequency furnaces (IFFs) that produce substandard steel In order to reduce the capacity, shutting down substandard factories is necessary For that reason, in 2017, Chinese government has paid more attention in closing IFFs In January 2017, in an update to regulations governing entry into the iron and steel scrap processing industry, MIIT started prohibiting the sale of scrap to IFF operators, starving them of their main raw material In February 2017, the National Development and Reform Commission and four other top government agencies reiterated the importance of cracking down on excess capacity and IFFs churning out low-quality steel A reminder on the 30 June deadline was also served Furthermore, banks are forbidden to lend to the targeted companies, and are told instead to support steelmakers that conform to capacity cuts and environmental regulations China’s central government has set 30 June as the date for the elimination of IFF-based steel production, which would be the cornerstone of its supply-side structural reforms of the industry in 2017 Earlier measures for curbing induction steel output have failed to deliver results, but this time round, the government seems to have set its mind on removing such steel-making capacity According to China’s Metallurgical Industry Planning & Research Institute (MPI), the capacity of IFFs is estimated at 80-120 million tonnes a year, with about 30-50 million tonnes produced in 2016 We think that shutting down substandard steel players should be a key step towards achieving an effective capacity cut IFFs are estimated to account for about 10% of China’s total steel-making capacity and its products, about 3.7% of total production To facilitate the country’s supply-side reform measures, Siyuanhe Steel Industry Restructure Fund was established on April 2017 in Shanghai Among the four participants is China’s Baowu Steel, which will hold 25% (US-China Green 25%, WL Ross & Co 26%, China Merchants Finance Holdings 24%) The US$5.9billion fund is expected to launch in June 2017 In conclusion, since 2016, the Chinese government has strengthened the capacity cut in the steel industry and achieved significant results However, there are still a lot of limitations in the cut which will be discussed in the next part III Impacts of the capacity cut: Positive impacts: a Improving environmental conditions: Eliminating excess steel capacity and restructuring the industry has enormous environmental significance because steel industry is the second largest emitter of air pollution in China, as well as second largest coal consumer and emitter of CO2, after the power sector In the Beijing region (Beijing-Tianjin-Hebei), the share of steel industry in emissions even exceeds coal-fired power, due to the heavy concentration of China's steel industry in the region 10 The chart shows the air pollutant emissions in Beijing region - the most concentrated place of steel production It can be seen that a very large portion of emissions come from iron and steel manufacturing activities The cut in steel capacity is expected to lead to the reduction of output as well, which could result in the improvement of environmental conditions in China Besides, the shutting down of substandard factories and fernaces could also contribute to reaching environmental targets of the country If the output rises in the coming years, this rise will also come from factories which fully meet environmental standards set by the government, thereby help resolving the serious pollution which is currently a severe problem to China In fact, the Chinese government had conducted the steel output cut from 2014 However, this did not last long, as Chinese steelmakers started to raise the production output again in 2016 The government has found another way to deal with the root of the issue, meaning the overcapacity, which lead to the decision to cut the steel capacity in 2016 11 Source: Greenpeace East Asia PM2.5 pollution levels in the Beijing region were improving rapidly from the beginning of 2014, when national air pollution action plan measures started to bite and steel industry output was slowing; when steel output started to surge in early 2016, the improvements in air quality stalled and reversed Figures show that the capacity cut can actually help improve the air pollution in China However, the shortcomings of the overcapacity reduction recently could threaten to undermine the effectiveness of the entire policy of cutting excess industrial capacity, unless addressed soon Most of the capacity elimination target set for the 2016-2020 period has, technically, already been achieved in 2016, meaning that capacity elimination in 2017-2020 will be much more modest unless targets are increased b Easing the real estate bubble: The prolonged reduction of steel capacity is likely to ease the housing bubble situation, as the property sector accounts for the majority of steel consumption in China The cut in steel capacity could lead to the higher steel prices and lower steel 12 consumption in the real estate industry This would result in higher housing and other real estate prices, as well as eliminating the situation of widespread building and selling houses at cheap prices, from that preventing the housing speculation Some cities, such as Nanchang, Xian and Zhongqing, are also beginning to tighten their purchasing power Home sales growth slowed from 26.2% in June to 4.7% in July and 3.4% in August This has been the lowest growth rate since March 2015.3 Negative impacts: a Unemployment: The Chinese government predicted that 1.8 million jobs would be lost due to the structural reform in the steel sector They also imposed policies to help the workers Major developments in resettling laid-off employees—that is, assisting them in finding new jobs—include: Yaya Ozaki, Iron ore sinks as market readies for post-congress China, https://asia.nikkei.com/Markets/Commodities/Iron-ore-sinks-as-market-readies-for-post-congress-China 13 February 25, 2016: The central government decided to establish a fund of 100 billion renminbi4over two years to compensate workers laid off because of capacity cuts in iron, steel, and coal sectors. The Ministry of Finance released specific guidelines5 on using the fund on May 10, 2016 February 29, 2016: the Human Resources and Social Security announced an estimated total of 500,000 employees in the iron and steel industry, and 1,300,000 employees in the coal sector, would have to be resettled because of capacity cuts March 1, 2017: The Human Resources and Social Security stated that during 2016, a total of 726,000 employees in the coal, iron, and steel sectors were resettled In addition, the minister stated that the estimated number of employees in the three sectors that will be laid off in 2017 is around 500,0007 However, the problem comes from the implementation of these aids in local levels The steel industry in China has been developed since the Mao period (through Great Leap Forward and Cultural Revolution) In rural areas, working in steel factories become the major job, even the obly job, of many families Therefore, shutting down furnaces will put these people into the unemployment conditions, whereas they not have necessary skills and knowledge to find a new job Therefore, providing subsidies for people loosing jobs in the reform can only solve the issue in the short run, but cannot assure the lives of these workers in the long run That is not to mention the corruption and lack of transparency in conducting these aid packages in the provincial levels Therefore, in order to guarantee the future for 1.8 million workers who would become unemployed during and after the capacity cut, the Chinese government needs to pay more attention in the deployment of unemployed assistance packages in localities 中央政府拿出 1000 亿元用于去产能职工安置, http://www.gov.cn/xinwen/2016-02/25/content_5046143.htm 《 》, http://jjs.mof.gov.cn/zhengwuxinxi/zhengcefagui/201605/t20160519_1998021.html 答记者问, http://www.china.com.cn/zhibo/zhuanti/ch-xinwen/2016-02/29/content_37897549.htm 国新办举行就业和社会保障有关情况新闻发布会图文实录, http://www.scio.gov.cn/xwfbh/xwbfbh/wqfbh/35861/36325/wz36327/Document/ 1543420/1543420.htm 14 b Unpaid debt: The closing of factories and furnaces will put a burden of debt on both the government and private steelmakers However, until now, the Chinese governmnet has not impose any mechanisms or policies to help deal with the rising of bad debt According to Chinese Beige Book International's survey, based on data from more than 3,000 Chinese enterprises and the China Beige Book, while the steel industry is facing overcapacity, enterprises still borrow money to invest, leading to the continuous increase in debt within the setcor8 The chart indicates that the debt within China’s steel sector has risen very rapidly over the years In 2014, 68.3% of Chinese steel companies’ assets were financed by loans Therefore, if these companies are bankrupted or forced to close, the debt burden on owners or shareholders will be very significant In addition, the official statistics of the Central Bank (PBoC) showed that bad debt has been increasing continuously in recent years In 2012, bad debt ratio in China was less than 1%, but from 2013 onwards bad debt has begun to form a trend of continuous rising By the end of the second quarter of 2017, China's bad debt was at 1.74%, marking the highest level since 20109. South China Morning Post, China’s Beige Book warns of “darker story” ahead for economy, http://www.scmp.com/news/china/economy/article/2113027/chinas-beige-book-warns-darker-story-aheadeconomy 二季度商业银行不良贷款率为 1.74%, http://paper.people.com.cn/rmrb/html/2017-08/15/nw.D110000renmrb_20170815_6-02.htm 15 Furthermore, with the reduction in steel capacity, steel prices are expected to rise rapidly in the coming time The result of this will be many investors and steelmakers entering the steel market of many investors However, this trend will only raise the amount of debt in the steel industry, as producers tend to borrow capital from banks and financial institutions to invest instead of using their own money Therefore, the Chinese government should have mechanisms to prevent the excessive borrowing of capital as well as packages to deal with the current oustanding debt caused by the shutting down of steel factories c Security and defence: Steel is a very important material of the defence industry, as it is used to make weapons, ships, fighter jets, vehicles, Therefore, the excess capacity to some extend is good for the security and defence of the country, as in case of rising threats from wars and insecurities, steelmakers can boost their production to meet the demand weapons and vehicles Therefore, decreasing the capacity to the level which is equal to the demand could be a very dangerous decision For that reason, the Chinese government will not cut the capacity too significantly The expected capacity cut set by the Chinese government is very remarkable, as it is even higher than the production output of the second-largest steel producer in the world which is Japan However, it is very easy to find that the reduced amount until 2020 is even lower than a half of the overcapacity in 2015 Although China wants to raise the economic efficiency of its industries, it cannot risk the country’s security for the socio-economic purposes IV Policy recommendations: 16 In the short run: - Strictly controlling the environmental standards of steel factories and enterprises which newly enter the market, as well as continuing the shutting down of substandard furnaces Enforcing the conduction of environmental protection policies, especially in provinces where the steel production concentrates - Strictly monitoring the implementation of unemployed assistance packages in the local levels (forming a committee or an inspection team to supervise this process) Organizing vocational traning programmes and job centres for workers who lost their job due to the steel-supply structural reform in China - Setting a mechanisms to prevent the excess borrowing of capital from banks and financial institutions of steelmakers Putting forward packages to help owners of closed factories deal with bad debts - Controlling the market-entry of new steel producers to avoid the continuous rising in steel capacity and debt within the steel sector, as well as guarantee the meeting of environmental and labour requirements In the long run: - Adhere to structural adjustment To resolve the excess capacity as the core, actively and steadily to the implementation of production capacity, to focus on intelligent manufacturing, promote industrial restructuring and upgrading, mergers and acquisitions as a means to deepen the coordinated development of regional distribution - Adhere to innovation-driven Strengthen the innovation of the dominant position, improve production and research with collaborative innovation system, stimulate innovation and creativity, to crack the steel material research and development problems as the breakthrough point, a comprehensive lead industry transformation and upgrading - Adhere to green development To reduce energy consumption and reduce emissions of pollutants as the goal, the full implementation of energy-saving emission reduction upgrading, and constantly optimize the fuel structure, vigorously 17 develop the circular economy, and actively research and development, promotion of the whole life cycle of green steel to build a new pattern of iron and steel manufacturing and social harmony - Adhere to quality first Strengthen the quality of the main responsibility of enterprises in order to improve physical stability of product quality, reliability and durability as the core, enhance quality management technology to enhance management, increase brand development efforts to achieve quality and efficiency changes - Adhere to open development To promote reform, promote development, promote innovation, make full use of domestic and foreign markets and two resources, adhere to the "excellent into excellent", and actively introduce overseas investment and advanced technology, and comprehensively promote international steel production cooperation REFERENCES AAM (2016), Steel and the US Economy, http://aamweb.s3.amazonaws.com/uploads/resources/projectgreenwood_factsheet_s teelfacts_11.2.pdf; Báo Giao thông (2016), Ngành thép Trung Quốc tự bắn vào chân mình, http://www.baogiaothong.vn/nganh-thep-trung-quoc-dang-tu-ban-vao-chan-minhd149845.html US Department of Commerce (2017), Steel export report: China, https://www.trade.gov/steel/countries/pdfs/2016/annual/exports-china.pdf Yaya Ozaki (2017), Iron ore sinks as market readies for post-congress China, https://asia.nikkei.com/Markets/Commodities/Iron-ore-sinks-as-market-readies-forpost-congress-China 中央政府拿出 1000 亿元用于去产能职工安置, http://www.gov.cn/xinwen/2016-02/25/content_5046143.htm 《 》, http://jjs.mof.gov.cn/zhengwuxinxi/zhengcefagui/201605/t20160519_1998021.html 18 答记者问, http://www.china.com.cn/zhibo/zhuanti/ch-xinwen/2016-02/29/content_37897549.h tm 国新办举行就业和社会保障有关情况新闻发布会图文实录, http://www.scio.gov.cn/xwfbh/xwbfbh/wqfbh/35861/36325/wz36327/Document/ 1543420/1543420.htm South China Morning Post (2017), China’s Beige Book warns of “darker story” ahead for economy, http://www.scmp.com/news/china/economy/article/2113027/chinas-beige-bookwarns-darker-story-ahead-economy 二季度商业银行不良贷款率为 1.74%, http://paper.people.com.cn/rmrb/html/201708/15/nw.D110000renmrb_20170815_6-02.htm https://www.reuters.com/article/us-steel-eu/china-to-cut-steel-capacity-butexcess-output-still-expected-eurofer-idUSKBN18703O https://secured-static.greenpeace.org/eastasia/PageFiles/299371/Steel %20Overcapacity,%20Feb2017/GPEA%20Media%20Briefing_Research %20Report%20on%20Overcapacity%20Reduction%20in%20China%E2%80%99s %20Steel%20Industry.pdf http://marketrealist.com/2017/10/catalysts-drive-cliffs-valuation-higher-4q17beyond/ http://www.thesaigontimes.vn/165127/Nganh-thep-toan-cau-hoi-sinh-khiTrung-Quoc-cat-giam-cong-suat.html http://fortune.com/2016/03/03/china-mass-layoffs-steel-coal/ https://bmsc.com.vn/tin-tuc/tin-doanh-nghiep/Nhu-cau-trong-nuoc-tang-caosan-luong-thep-Trung-Quoc-lien-tuc-pha-ky-luc-246071.html http://ndh.vn/trung-quoc-thuc-hien-cat-giam-san-luong-thep-som-hon-so-voimoi-nam-2017101310528673p150c168.news https://www.businessinsider.com.au/category/china-steel-demand http://paper.people.com.cn/zgnyb/html/2016-05/16/content_1680276.htm https://www.worldsteel.org/steel-by-topic/statistics.html 19 ... Overall of the Chinese steel industry in the 2006 - 2016 period: b The overcapacity in the Chinese steel industry: c Causes of the overcapacity in the steel industry: II Capacity cut measures... CONTENT I Definition of overcapacity and the overcapacity in the Chinese steel industry: Definition of overcapacity: 2 The overcapacity in the steel industry of China: ... overcapacity within the industry The excess capacity in the steel sector have increased significantly over the years, leading to the remarkable drop in prices b The overcapacity in the Chinese steel