21/03/2017 - 17:55

OECD calls on China to cut steel capacity

21/03/2017 - 17:55

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Almost 500,000 workers would need to be laid off in China’s steel industry by 2020 under a plan to reduce excess capacity, according to a report released by the international Organisation for Economic Cooperation and Development this week.

Steelmaking in Asia drives iron ore demand in Australia.

Almost 500,000 workers would need to be laid off in China’s steel industry by 2020 under a plan to reduce excess capacity, according to a report released by the international Organisation for Economic Cooperation and Development this week.  

A reduction in steel capacity would lead to higher steel prices, with the impact to flow through to the iron ore market, Western Australia’s biggest export.

When the Chinese government announced in January it would cut steel capacity by around 30 million tonnes in 2017, iron ore futures on the Shanghai exchange reportedly jumped 8 per cent.

The numbers highlighted by the OECD, which are based on a Chinese government report, suggest further reductions in capacity are needed.

About 150mt, or 13 per cent of the nation’s annual steelmaking capacity, would need to be taken out of the market, according to projections cited by the OECD.

The OECD said the current excess capacity was reducing profitability and leading to poor resource allocation, which stifled productivity.

Utilisation rates in the steel industry are currently close to 70 per cent, the report said, and it predicted around 500,000 of the country’s 3.7 million steel industry employees would need to be let go.

Even with that reduction, the impact on price could be limited.

“Moreover, despite the capacity reduction targets, declining demand for steel and demand weakness in several other sectors affected by overcapacity imply that capacity utilisation rates may not improve much in the short term,” the report said.

“This will keep prices down and force or keep otherwise efficient private companies out of the market.”

The OECD additionally said China had eliminated around 65mt of capacity in 2016, although there has been debate over the veracity of that estimate, with environmental organisation Greenpeace last month reporting that capacity had actually grown in 2016.

Housing

Threats to the Chinese economy came from rising enterprise debt and the possibility of a burst housing bubble, the OECD said.

So-called "tier-one" cities in particular had experienced high price growth, with a year-on-year change of between 20-30 per cent in the past two calendar years.

In a recent note to investors, Bank of America Merrill Lynch equity strategist David Cul similarly flagged housing prices as being a potential source of problems.

“Based on (the ratio of housing value over household income), China is the second most expensive market among the countries that we track, all with a reputation of excessive housing price at various times,’’ Mr Cul said in the note

“China’s high ratio currently doesn’t necessarily mean the housing price will drop sharply anytime soon – Japan’s and Ireland’s had reached far higher levels before theirs corrected while Australia’s, Korea’s, and indeed, China’s, have stayed at high levels for years without any major price correction so far.

“However, a few factors could make housing price in China over the next few years more vulnerable than most, including financial system risk posed by a rapid rise of leverage economy-wide, and a lack of exchange rate flexibility.”

The OECD found that the financial sector would likely be able to weather any problems, thanks to prudential regulations, among other factors.

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