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RPT-COLUMN-Can China reform its bloated steel sector?: Andy Home

(Repeats Feb. 3 story without changes to text. (The opinions expressed here are those of the author, a columnist for Reuters.))

LONDON, Feb 3 (Reuters) - The crisis in the British steel industry risks becoming a “death spiral”, according to Angela Eagle, business spokeswoman for the country’s opposition Labour Party.

Her bleak warning came during a parliamentary debate on the lengthening list of British steel plant closures and redundancies, which have claimed around one-sixth of the steel workforce over the last six months.

The country’s steel production dropped by 10.4 percent last year.

This is not just a British problem.

Steel production is falling just about everywhere. Of the top 10 national producers only one, India, raised production last year, according to the World Steel Association.

And everyone knows what the problem is.

China.

The country stands accused of dumping steel onto world markets, depressing prices and triggering plant closures.

A backlash of trade complaints and anti-dumping duties is building.

In Europe, debate is raging about whether to grant China market economy status, a move critics claim will make it harder to impose the sort of anti-dumping duties just levied on Chinese reinforcing bar (rebar).

“Most of the EU steel industry may disappear,” warned Axel Eggert, director general of EU steel industry body Eurofer.

But, ironically, China itself is suffering from its own previous steel excess just as much as anyone else.

Indeed, restructuring the steel sector is going to be a key test of Beijing’s ability to re-engineer its economy away from the old fixed-asset-investment model towards a more consumerist version.

The scale of the task mirrors the scale of the steel monster that years of unbridled investment have spawned.

STEEL MONSTER

China has built a steel leviathan over the last decade. The country now accounts for around half of global steel output.

The boom was fed by the country’s massive infrastructure and property programmes unleashed in the wake of the global financial crisis.

That spending splurge has now run its course as Beijing grapples with the resulting overhang of unsold housing stock.

China’s own steel demand probably peaked in 2014, according to the China Iron and Steel Association (CISA), a grouping of 100 or so of the country’s top producers.

Production seems to have peaked shortly after and it actually fell last year to the tune of 2.3 percent.

That may not sound like much but the year-on-year drop of 19 million tonnes dwarfed the 11 million tonnes produced in Britain last year.

It also marked a tectonic shift.

It was the first time in more than three decades that Chinese steel production has fallen in any one year. As recently as 2013 the country was still notching up double-digit growth in steel output.

But output is still mismatched with demand and it is that gap that is roiling the rest of the world in the form of accelerating steel exports.

There were 112 million tonnes of Chinese steel exports last year, an almost unbelievable amount of metal, more than the entire output of North America.

Even more frightening for everyone else is the fact export flows may not have peaked yet.

December’s tally of 10.65 million tonnes was the second highest monthly total, after September’s, and equivalent to an annualised 128 million tonnes.

Such elevated exports may be viewed as aggressive dumping by the rest of the world but they are also a sign of the stresses running through China’s steel sector right now.

And given the sheer scale of the sector, Beijing’s success or otherwise in reforming it will determine whether it can shift the broader Chinese economy away from its addiction to government infrastructure spending.

BAD DEBTS, BAD AIR, BAD POLITICS

The bloated steel sector is a major headache for Beijing.

Not only is China producing far too much steel for its own needs, it is also sitting on massive excess capacity, maybe as much as 300 million tonnes, according to CISA.

That is why steel prices in China have been falling for many years.

The Shanghai Futures Exchange’s rebar contract is currently trading at just under 1,800 yuan per tonne, compared with almost 7,000 yuan in late 2009 when Beijing’s infrastructure bonanza was in full flow.

The relentless deterioration in prices is piling up losses across the sector.

CISA estimates that more than half of its 100 members were in the red in the first 11 months of 2015. Cumulative losses totalled 53.1 billion yuan ($8.07 billion).

To bad debts can be added bad air.

Steel production is a major source of air pollution in a country that is waking up to the environmental legacy of years of unrestrained heavy industrial growth.

And to bad air can be added bad politics.

The furore over Chinese steel exports risks derailing more important policy goals, such as that much-coveted market economy status.

On all counts, the solution is simple. Beijing is going to have to cut steel production capacity.

CREATING AN EXIT

And that’s where things get difficult.

In China’s version of state capitalism, market forces will not do the trick alone.

Beijing has allowed a number of the most financially stricken producers to go under, even state-owned ones.

But the problem is that, to quote Zhang Guangning, chairman of CISA, there is no natural exit route for most loss-making mills.

“Some enterprises want to exit, but an exit route has not been opened up...and some local governments continue to urge steel firms to produce in the interests of local economic development and social stability,” he explained.

Central government intervention will be needed and China’s State Council has just announced its intention to close 100-150 million tonnes of steel capacity.

It has also put a price on that decision, the loss of around 400,000 jobs, according to the official Xinhua news agency.

That compares with the 5,000 jobs lost in Britain in the last few months, which have generated so much political heat.

Nor does China enjoy the sort of social security safety net applying to laid-off workers there or anywhere else in Europe.

The country simply doesn’t have an existing template for laying off that many workers, especially if it’s going to attempt a simultaneous process in the equally leviathan coal sector.

Such “large-scale redundancies in the steel sector could threaten social stability,” according to Li Xinchuang, head of the China Metallurgical Industry Planning and Research Institute.

Such is Beijing’s dilemma.

Not doing anything to curb the Chinese steel monster is no longer an option. But the risks of doing the right thing cut to the heart of the social contract underpinning the Chinese state.

Reforming the steel sector is going to be a Herculean task even for China’s central planners, but without reform it risks derailing the broader goal of shifting the economy towards a more consumerist model.

The good news is that Beijing seems to be preparing the ground, politically and socially, for a campaign of forced closures.

The bad news is that such a campaign is going to take time, possibly a lot of time. The State Council’s promise to eliminate capacity notably didn’t include a time frame.

Exports, in other words, are going to continue at their accelerated pace for the foreseeable future. And that means political and trade tensions are going to continue rising. (Editing by Adrian Croft)

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