Chinese overcapacity is worsening, EU Chamber warns

BEIJING, Nov 26 (Reuters) - China needs far-reaching structural reforms to root out industrial overcapacity, which is doing untold damage to domestic growth and the global economy, according to a report released on Thursday.

Excess capacity is a long-standing scourge in China, but its impact has become ever more destructive as a result of the global financial trauma, said the study by the European Union Chamber of Commerce in China.

"The crisis has throttled demand for exports from China at a time when even more investment, in the form of the Chinese government's massive stimulus package, is being pumped into building new plants and adding unnecessary capacity.

"As a result, the problem is actually getting worse in many industries," the report said.

The State Council acknowledged in August that overcapacity was blighting many industries and that local governments were expanding capacity "blindly".

The cabinet subsequently singled out iron and steel, cement, electrolytic aluminium, glass, coal chemical, polysilicon and wind power equipment as the worst offenders and announced steps to rein in their expansion.

"The European Chamber welcomes these very positive measures, but we also caution that much remains to be done to bring overcapacity under control and to create the economic and political conditions to ensure that it does not re-emerge in the future," the report said.

By wasting resources and eroding profits, overcapacity deters research and development and encourages firms to cut corners on health and safety standards as well as environmental protection.

Further, the creation of unneeded capacity raises the risk of non-performing loans for banks that finance the investment. It also generates trade tensions as producers offload their surplus production overseas at cut-rate prices, the study said.

"Since trade frictions hamper supply chains, this is a major threat to globalisation's positive effects," it said.

FAR-REACHING REFORMS

To curb overcapacity, China must shift from investment- and export-led growth and focus more on domestic consumption and services, the Chamber argued.

To that end, it made a series of recommendations that amount to a root-and-branch overhaul of China's economic model. They include:

-- To redistribute national income from firms to households; state-owned enterprises should disgorge dividends for the government to spend on social security, health and education instead of ploughing profits back into fresh investment.

-- Companies must slash capital expenditure in coming years.

-- Remove subsidies for energy and other inputs, provided indirectly by households, to which manufacturing has become addicted; increase resource and environmental charges.

-- Currently low interest rates subsidise bank borrowing by manufacturers and must rise to reflect the real cost of capital; let the yuan's exchange rate gradually appreciate.

-- Reform the fiscal system to give more funding opportunities to local governments, which now compete to attract industrial investment for the tax revenues and jobs it generates.

This was the main macroeconomic reason for overcapacity, according to 56 percent of respondents to an European Chamber survey conducted for the report, followed by loose lending policies. The top microeconomic reasons were firms' high growth expectations, followed by lax enforcement of environmental rules.

For an analysis on overcapacity, clock on [ID:nPEK303585] (Reporting by Alan Wheatley; Editing by Ken Wills) ((alan.wheatley@thomsonreuters.com; +86 1391 007 9146; alan.wheatley.reuters.com@reuters.net)) ((If you have a query or comment on this story, send an email to news.feedback.asia@thomsonreuters.com))