“We cannot be blindly optimistic,” Premier Wen Jiabao was warning last week.
In which case he might want to get on the phone to the People’s Daily, in light of a euphoric piece penned recently by the newspaper.
In the editorial at the end of July, the Daily gushed forth on the “boundless vitality” of the domestic economy, and the spirit of heroism, foresight and constancy of purpose that underpinned it. This “unbreakable combination” was at the heart of China’s economic vim. It was the envy of other nations too.
But others – like Wen himself – are urging against complacency. They are also calling for a more controlled form of growth, to ensure a more balanced recovery. One specific concern is that too much investment is heading towards sectors already saturated in excess production and surplus output. Once again, China looks like it has an overcapacity problem.
Which sectors in particular?
The Ministry of Industry and Information Technology (MIIT) is especially concerned about the 100 million tonnes of excess steel capacity. That’s enough extra steel to construct 2,500 Sydney Harbour Bridges, or a similar number of Empire State Buildings.
Overcapacity in the cement industry – of at least 300 million tonnes – is also getting coverage. Bear in mind that this is at a time in which demand for both materials should be well above trend, because of the government’s stimulus spending on infrastructure.
Instead, it seems the Rmb4 trillion ($584 billion) package, as well as the flood of state-owned bank lending accompanying it, has prompted production capacity to race ahead of potential demand in a number of sectors.
There has been a 20% growth in new steel projects this year, says Chinastakes.com, and enough new cement factory construction to support an additional 200 million tonnes of annual output (cement investment in Sichuan province grew 60% in the first half, for example).
Shipbuilding, plate glass and polycrystal silicon production are also expanding faster than forecasted demand. And according to the Economic Observer, the investment growth rate for the first five months of 2009 hit 32.9%. Growth in industrial value-added – for which, read returns – was up a much lower 6.3% in the same period.
But the government is promising to get to grips with the problem?
A slew of official announcements have made it a policy priority.
One approach is to block new projects in industries in which overcapacity is most obvious. MIIT has frozen approvals of new steel projects for the next three years, for instance.
Another tactic is to force through sector consolidation, also underway in the steel industry. But smaller firms are prone to resist centrally sanctioned consolidation (see page 4), as are many local governments themselves.
A third approach is to concentrate investment where it is most needed, as part of attempts to move up the value-chain. This “empty the cage, change the birds” initiative began in the manufacturing heartlands of Guangdong in 2006. The government now wants to see it happening elsewhere.
But even here MIIT is cautious of over-investment, warning particularly against the risks of “repetitive construction” in solar power and wind power.
So China has had to deal with overcapacity before?
Newspaper reports from five years ago detail a similar range of issues, following a surge of state-led investment in the aftermath of the Asian financial crisis in the late 1990s.
Similar to today, Beijing tried to respond by tightening up on credit growth, and clamping down on licences for new projects.
But there are differences too. The scale of this international crisis is much greater for one thing. Last time around there was a strong international appetite for Chinese exports too. Today that demand is missing.
Still, some commentators think Beijing wouldn’t be trying to skim off some of the frothiness of the recovery if it wasn’t confident of its underlying substance.
Qu Hongbin, chief China economist at HSBC, also warns against undue alarm.
That’s because the majority of the current spend (about 60% of it) is going into core infrastructure rather than new industrial production or manufacturing capacity.
This is investment that the country still needs; Qu offers railway capacity as an example – China has only 6% of the world’s railway track but supports 24% of global freight transportation.
Qu notes too that the country’s ratio of national debt to GDP (still well below 20%) means that it has the financial firepower to make long-term investments that he says will confer multi-year benefits. He is also “more comfortable” that the investments in infrastructure (which normally generate more predictable cash flows) will hold non-performing loan ratios in check.
But others see a missed opportunity?
One criticism is that Beijing has set the economy back on an older path, and one that is unlikely to deliver as it once did. This is despite policymakers knowing that a process of deeper adjustment is required in the medium term, especially in generating greater domestic demand.
Last week the State Council again emphasised the importance of the quality of industrial growth, and not just the absolute amount. “Structural adjustment may trigger a slower pace of expansion in the short term,” the report said, “but it will do good to the economy in the long run.” But it seems it’s the shorter-term imperatives that tend to drive the final policy choices, especially the need to create jobs and a minimum of 8% annual GDP growth. This means that market-driven adjustment has taken a back seat; as rebates are reintroduced to keep struggling exporters afloat, or as state-directed lending allows the marginally profitable to stay in business.
That’s the view of Michael Pettis, a professor at Peking University’s Guanghua School of Management, voiced in an opinion piece in this week’s South China Morning Post.
So what comes next?
For the pessimists, demand for Chinese exports isn’t likely to scale up any time soon. Chinese consumers don’t want to take up a fuller share of the slack either. So the outcome – falling capacity utilisation and/or rising inventories– looks inevitable.
Optimists counter that Beijing can always choose to ratchet down the investment tempo, and there are signs that there is already a throttling back on bank lending. It also takes time to steer investment in a more productive direction; it isn’t going to happen overnight.
But, for Pettis, the question is whether the economy may not already be charted on an uncomfortable course, towards a scenario of dumping and rising trade tensions on the one hand, or write-downs and plummeting corporate profits on the other.
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