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2009-11-26 | All chapters

Stimulus-Driven Overcapacity In China Could Swamp World Markets, Says Group
Andrew Batson, Wall Street Journal, 27th November 2009

BEIJING – The new investments funded by China's stimulus plan may swamp world markets and lead to a surge in trade conflicts, an international business group said, in a sign of the rising concerns over the side effects of the government's drive to support growth.

The European Union Chamber of Commerce in China, in a report released Thursday, said a combination of easy credit and other incentives for Chinese companies to expand has led to the construction of many new factories in areas like steel, aluminum, cement and chemicals. The increase in industrial capacity – at a time of global economic weakness – could drive down profit margins worldwide and lead to a backlash from other countries, the chamber said.

"The Chinese stimulus package has poured credit into increasingly questionable projects and will almost certainly increase direct and indirect subsidies to investment and manufacturing," the report says. "China's growth model requires that external demand - the European Union and the United States - be able to absorb the overcapacity it produces," a prospect that is increasingly unlikely given the weak economic recovery in the developed countries. The chamber urged the U.S. and EU to help China change its policies to prevent a damaging eruption in trade disputes, which are already on the rise.

The chamber of commerce does represent businesses that could benefit if there were less competition from Chinese factories. But many analysts do believe that China's massive expansion of industrial capacity is tied to broader economic problems, like its persistent trade surpluses, high national savings rate and enormous foreign-exchange reserves.

China's government has also increasingly focused on the risks from the boom in bank loans and public-works projects. In recent months Beijing has announced restrictions on new investment on sectors it has identified as having excess capacity, and regulators have quietly moved to cool down the surge in bank lending.

"In many sectors the problems of excess capacity and redundant construction are still very serious, and in some areas they are even worsening," China's State Council said in a September statement. "It is not only traditional industries like steel and cement that are blindly expanding, but also new industries like wind-power equipment and polycrystalline silicon."

For instance, the government estimates that new steel mills capable of producing 58 million metric tons a year are now under construction – even though the industry's annual capacity, at 660 million tons last year, already exceeded domestic demand of around 500 million tons. Cement capacity is on track to reach 2.7 billion tons a year, against forecast demand of 1.6 billion tons, the government says, and methanol plants are operating at just 40% of capacity.

It has long made sense for Chinese companies to build more factory capacity than is immediately needed, since the country's rapid growth allows demand to quickly catch up with supply. What is excess supply in one year may not be enough by the next year. And so the recovery in China's economy this year has encouraged companies to invest in growing markets.

Steel production, for instance, has broken one record after another as demand from construction recovered strongly. And Thomas Wrigglesworth, an analyst at Citigroup, said the government actually planned much of the new steel capacity before the stimulus, in order to replace outdated mills with more modern facilities. "What's more worrying is that the closure of small and inefficient capacity hasn't really taken place," he said.

Rather than shutting down small steel producers, local governments often encourage them to expand to become more competitive. The chamber's report identifies a number of such systemic problems that encourage China's continued expansion of factory capacity. Many economists agree the economy has a bias toward investment, while noting that it's difficult to tell whether what looks like excess capacity now will turn out to be unneeded in the future.

"I think if one takes a static view, one tends to exaggerate the underlying problem. One has look at the demand side of the equation," said Wang Qing, an economist for Morgan Stanley. But Chinese companies do have large savings and easy credit, enabling them to quickly pile into new investments. "Whenever a profitable opportunity arises, there tends to be tons of money flowing into that sector, and increased supply results in compressed margins," he said.

Source: http://online.wsj.com/article/SB125920183074064831.html