More than enough

Chery Automobile has grand visions. In order to fulfill them, last month it began construction of a new factory in Wuhu. The plant in Anhui province will have a floorspace of around 1.61 million square metres. Lest that number seems a bit abstract: you could fit 16 Wembley Stadiums onto a piece of land that big. It will go into operation in 2012.

That’s a significant year, as there are some who fear that it will reveal a chronic overcapacity problem for China’s car industry.

That’s because Chery is not alone in its desire to build giant new car plants. China Business Journal reports that the country’s top 14 carmakers will have built so many factories they’ll have a combined output of 23 million vehicles in 2012. With other (foreign) carmakers included, the total figure the paper estimates, will breach 25 million.

Demand for cars meanwhile is expected to grow 10-15% annually – from 13.64 million units last year to 20 million in 2012. That suggests China will be making five million more cars per year than local consumers want to buy.

According to Japan’s Nikkei newspaper this “possibility of excess capacity” has led the Chinese government to launch a probe into the carmakers expansion plans and it may deny permits for construction of some new plants.

Does that signal trouble ahead?

It’s not just cars, unfortunately. Chinese planners are worried that there is overcapacity in quite a few industries – including the cement business, glassmaking and shipbuilding.

Last week the government stepped in. The Financial Times reported that the regulator had closed access to the equity markets for firms from six industries deemed to have overcapacity problems. The newspaper said that at least 34 companies had cancelled or reduced plans to raise money from the equity markets.

The government is concerned that these companies will use any funds raised to further boost production – and thereby worsen the problem. “The companies, including cement producers, said that they had been ordered to abandon fundraising plans because they were in sectors identified by Beijing as suffering from overcapacity,” wrote the FT.

So is overcapacity a big problem?

The Ministry of Industry and Information Technology (MIIT) reckons there is at least 300 million tonnes of excess capacity in the cement industry. Against this bleak assessment Chinastakes.com reports that last year there were enough new cement factories built to support an additional 200 million tonnes of annual output (cement investment in Sichuan province grew 60% in the first half, for example).

Meanwhile, the China Iron and Steel Association forecasts that the country’s steel production capacity will hit 720 million tonnes this year. MIIT is concerned there is (at least) 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. And yet again, perversely, steel capacity was added in 2009, not reduced.

How did that happen?

Blame the financial crisis, and the government’s response to it. Keen to avoid recession, the government launched a Rmb4 trillion ($584 billion) stimulus package, encouraged state-owned banks to lend Rmb9.59 trillion and introduced measures to pep up the previously slack real estate market.

It was quite a steroid, notes the Economic Information Daily. The strong emphasis on infrastructure investment, in particular, proved a boost to what it terms the “veteran overcapacity industries” of steel and cement – given you need a lot of both to build all those railway lines, roads and dams.

Speaking of those railway lines, there’s even some debate whether overcapacity hasn’t been created there too. Ignore the 200 million or so who are predicted to travel by rail during the Lunar New Year and the crowded photos of trains and station platforms. That is a seasonal anomaly.

The worry is whether the rapid laying of track – about $300 billion is being spent on 26,000km of new lines – will create uneconomic routes. One specific fear is that the country may have got ahead of itself in high-speed railways (where it is expected to account for half the world’s bullet train track by 2012).

The Beijing Times says the problem is the price of tickets: triple those of normal trains. It points out that on the newly opened Wuhan-Guangzhou line, the bullet trains are only 40% full. Migrant workers returning from the south for the Lunar New Year are crowding onto ordinary trains, but there’s still spare seats to be had on the high speed equivalent. “The public do not lack time,” comments the Beijing Times. “But they are short of money.”

On the more established Beijing-Tianjin high-speed line, it is reckoned the annual traffic is 18 million passengers versus a target of 38 million, according to data compiled by Professor Zhao Jian of Beijing Jiaotong University.

Should we be worried?

That is the million dollar question, and sadly there’s no easy answer. Within China itself the debate about overcapacity is akin to the proverbial question of ‘how long is a piece of string’. Take steel, which initially looks like a clearcut case.

But as one steel plant owner told China Economic Times: “I see very good market demand and despite our producing at full capacity we are unable to meet customer needs, and every day we receive reminders about orders from customers, so I don’t see where the excess capacity is.”

Or take the view of Mei Minxue, the director of the Office of Economic Operation at Tangshan’s Bureau of Industry and Information Technology. Says the Hebei-based official: “Since 2000, there have been people crying excess capacity, but how much iron and steel will China need in the end? Nobody can give a clear answer. In earlier times, experts said the production capacity had exceeded 100 million tonnes and that was enough for China. Soon the quantity exceeded 300 million tonnes, and experts said there should be no new steel projects. Last year it was more than 600 million tonnes. Who can give a clear answer on the quantity needed?”

Complicating the mix is poordata. Knowing how much steel China needs is a function of knowing how big its economy is. But even that is not totally clear. In a recent article for Forbes, Shaun Rein – who runs the China Market Research Group – said many assumptions about the country ignore a simple fact: the huge size of the underground economy. He thinks the size of China’s tax-evading black economy could be as large as Russia’s a decade ago, i.e. 50% of GDP.

If he is right, or even vaguely right, some of the assumptions about overcapacity may be exaggerated.

Any recent evidence?

Try the fact that car and vehicle sales doubled in the month of January. Yes, doubled (versus a year earlier), to 1.66 million units. But once again, such strong demand must be put in context: in this case favourable purchasing policies were extended by the government. These were originally framed to encourage car buying during the financial crisis. People are evidently buying now in expectation that such tax-breaks won’t last much longer.

In fact, there are two areas that should quickly determine where and how much surplus capacity exists. The first is what happens as the stimulus spending gradually winds down. The second – and somewhat related area – is what happens in the real estate market. If it slows dramatically – as it did in 2008 – new construction will tail off. That will hit the steel, cement and glass industries hard.

Nor is this a theoretical point: the government has already moved to slow property prices. And on Thursday the central bank announced a “gradual” exit from its stimulus policy.

What’s the game plan?

The authorities are definitely worried about overcapacity, and according to the 21CN Business Herald the bank regulator, the CBRC, sees trouble ahead. For example, it is concerned that after the stimulus spending peters out a steel glut will see prices drop and banks will accumulate bad debts. It has even ordered banks to cut back loans to smaller steel firms (as well as cement producers) according to a circular seen by the Herald’s reporters.

This ties in with another government policy, and one which WiC has repeatedly mentioned: consolidation. The smaller players in all the ‘overcapacity’ industries tend to have the oldest plants and equipment, and as a result are the least efficient (wasting energy and causing greater pollution).

Xin Guobin of the Ministry of Industry and Information Technology predicts 2010 will be the year in which a “breakthrough” will be made. A “systematic” M&A policy, he says, will create fewer but stronger players in the ‘overcapacity’ industries. Simultaneously by raising environmental standards – and curtailing access to finance – the plan is to eliminate the smaller and less efficient players. Ergo, no overcapacity.

It all sounds good, till you consider what happened in Shanxi last year (see WiC48, page 7). That fixed one problem and created another.

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