Battling Overcapacity, China Orders Wide Shutdown of Outmoded Industrial Operations

Capacity Cut Targets Energy-Intensive and Polluting Industries

The Ministry of Industry and Information Technology (MIIT) disclosed a list of 2,087 companies for the capacity retirement drive, spanning 18 industries including mostly energy-intensive and highly-polluting sectors such as iron and steel, cement, glass, coking coal, paper and pulping, and dyeing. These firms are required to shut down their outdated manufacturing capacity by the end of September, or face penalties ranging from the revocation of sewage discharge permits and the withdrawal of new credit support, to the suspension of the approval of new projects, power blackouts and the stopping of allocation of additional industrial land.

The most heavily targeted industry in this latest overcapacity crackdown is cement, with over one-third of the 2,087 targeted firms—762 in total—being cement manufacturers. Also included in the list are 279 paper and pulping firms, 201 printing and dyeing companies, 192 coking coal firms, 175 iron plants and 143 iron alloy plants. In terms of geographic distribution, 230 of the affected firms are located in Henan province, 226 in Shanxi province, 180 in Zhejiang province, 165 in Hebei province, 165 in Yunnan province and 128 in Guizhou province. Except for Zhejiang, all these most affected regions are located in central or western China. The MIIT released the provincial-level capacity-retirement quota in May 2010, and the quota was allocated to individual firms by provincial governments at the end of July, according to the MIIT statement.

Capacity Curb Is More Aggressive than Expected

The capacity retirement is more aggressive than expected, as the scale of shutdown by September this year will exceed this year's original plan by a considerable margin for many key sectors, such as iron, coking, cement, glass, and paper & pulp. Glass capacity retirement, for instance, is exceeding plan by 53%, coking 22%, and iron 17%. With the completion of the capacity retirement by September, the actual capacity cut during the 2006-10 period will exceed the original five-year plan by 64% for the paper and pulp industry, 39% for cement, 35% for coking, 25% for steel and 17% for iron.

According to an earlier disclosure of MIIT, China as of the end of 2009 already retired 81.7 million tonnes of iron capacity, 82.5 million tonnes of coking coal capacity, 240 million tonnes of cement capacity and 6 million tonnes of paper and pulping capacity. Five industries, including steel, calcium carbide, coking coal, iron alloy and monosodium glutamate (MSG), had already met the capacity retirement plan set down for the 11th five-year plan period (2006-10). Nevertheless, outmoded capacity still made up 15-25% of total capacity in the 18 targeted industries. Specifically, that ratio was 20% for both the iron and cement industry—at 100 million tonnes and 500 million tonnes respectively.

Outlook and Implications

The sweeping capacity curb was announced by the MIIT just days after the national statistics authority released data showing that China's energy intensity, measured by energy consumption for every 10,000 yuan of GDP, gained 0.09% in year-on-year (y/y) terms in the first half (H1). Although down sharply from the 3.2% y/y gain reported for the first quarter, a marginal gain in energy intensity in the first half still means that China is probably missing its energy-intensity reduction target for the 11th five-year plan period, which ends this year. According to the plan, China is to reduce energy intensity by 20% from the 2005 level by the end of this year. During the four years from 2006 to 2009, energy intensity was slashed by about 14.4%, and the country still needs to cut 6-7% this year from last year's level to attain the 20% cumulative cut target—which looks to be an increasingly unrealistic goal.

Energy conservation and environmental goals aside, the energy-intensive target has been used mainly as a macro control policy lever that the Chinese central government has been utilising in pursuing its broad industrial structure adjustment and consolidation strategy in the long run and instituting macroeconomic retrenchment in the short run. Indeed, the stepped-up crackdown on energy-intensive sectors in the second quarter of this year, following initial signs of overheating at the start of this year, has been one major factor causing the recent cooling-off of the Chinese economy—with the Chinese industrial production growth in the first half falling to 17.6% y/y, down from 19.6% y/y in the first quarter, led by a sharp deceleration of energy-intensive heavy industrial sectors. While China's overall macro control is expected to shift to neutral in the second half due to concerns on hard landing, there is no sign yet that control on the energy-intensive sectors will loosen up—given the heightened overcapacity risk that has been accumulated in those sectors following the investment stimulus cycle of last year and amid the anaemic recovery of global demand. Such retrenchment is likely to be of a long-term nature based on the country's current development strategy as well as an outlook for a possibly protracted shift in demand, and what is likely to fill the void of those traditional sectors could be new strategic sectors—such as new energy and new materials—that have been advocated by Chinese leadership since the end of last year.