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Print Edition> Business
UPDATED: December 2, 2013 NO. 49 DECEMBER 5, 2013
Trimming Production
Market mechanisms hold the key to reducing industrial overcapacity
By Lan Xinzhen

LESS IS MORE: A clay stove in Tangxian County, Hebei Province, is dismantled. Overcapacity seriously impedes China's transformation of its economic growth model (ZHU XUDONG)

Although in recent years the Chinese Government has been controlling and cutting surplus capacity, this year's measures are particularly stern, sending a signal to foreign investors planning new projects in China to avoid industries embroiled in excessive overcapacity.

In October, the State Council, the country's cabinet, released the Guideline to Tackle Serious Production Overcapacity, listing five sectors with serious overcapacity: cement, electrolytic aluminum, sheet glass, shipping and steel. According to the guideline, in five years the Chinese Government plans to get production capacity in the five industries down to a reasonable level compatible with the environment, market demand and resource supplies.

The guideline aims at tackling surplus through measures such as prohibiting newly built projects, closing unqualified projects, reducing surplus capacity through mergers and acquisitions (M&As) and expanding domestic demand.

The State Council required related ministries and commissions to formulate detailed measures. On November 13, the Ministry of Industry and Information Technology (MIIT) issued a document on thresholds for the shipbuilding industry, putting forward specific requirements in production facilities, equipment, measurement and detection, construction technical capacity, technology innovation, quality assurance system, energy conservation, and environmental protection. Enterprises that fail to meet these requirements will be shut down.

The Ministry of Land and Resources announced on November 15 it would strengthen control of land resource development and stop approval of land use by projects in steel, cement, electrolytic aluminum, sheet glass and shipbuilding industries with serious surplus capacity. No land will be granted for newly added capacity for already existing projects in these industries.

Fu Baozong, an associate researcher with the Academy of Macroeconomic Research under the National Development and Reform Commission (NDRC), says the guidelines will play a key role in boosting industrial upgrading and transforming the economic growth model.

Bottom line

China used to have a very serious problem in demand outstripping supply. The situation improved after the policy of reform and opening up in 1978, but supply still failed to meet demand. However, investment soared after China's accession to the WTO in 2001, leading to surplus capacity in some industries.

According to figures from the NDRC, at the end of 2012 only 72 percent, 73.7 percent, 71.9 percent, 73.1 percent and 75 percent of production capacity in China's steel, cement, electrolytic aluminum, sheet glass and shipbuilding industries had been utilized. That is to say, about one fourth of production capacity in these industries was excessive.

There are still cases where new projects are planned in these industries, likely to intensify the overcapacity problem.

Excessive capacity drastically has cut profits among these industries, with most enterprises facing tough times. According to a report by Shanghai Securities News, by the end of September, among all 959 manufacturing companies listed on the A-share market in Shanghai and Shenzhen, the total inventory had reached 1.14 trillion yuan ($185.97 billion), while the inventory turnover time was as long as 168 days. Many enterprises have their funds lying idle in inventories.

According to the MIIT figures, in industries with excessive capacity the average sales profit rate is below 3 percent, much lower than the average profit rate of 7 percent in all industries. Of these, steel companies have the lowest profit rate—lower than 1 percent—among all industries.

Also, the average asset-liability ratio in industries with overcapacity is around 60 percent, bringing huge pressure to bear on cash flows and financing sources. The asset-liability ratio of the steel industry stands at 70 percent, and a few steel companies have their ratios higher than 100 percent.

If the overcapacity problem is not solved, it will inevitably intensify cut-throat market competition and enlarge industrial losses, the shutdown of enterprises, unemployment of workers and non-performing assets of banks, jeopardizing sound development of industries and the Chinese economy.

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