Overcapacity troubles economy, reform needed

BEIJING -?Although economic figures for March indicated a more stable economy in China, overcapacity continues to trouble the country's industries.

China's purchasing managers' index (PMI) for the manufacturing sector rose to 50.9 percent in March, representing positive growth, according to data released by the Federation of Logistics and Purchasing (CFLP) on Monday.

However, the sub-index for finished product inventories went over 50 after declining for eight consecutive months, indicating a worsening situation of excess production capacity.

A PMI reading of 50 or greater indicates expansion, while a reading below 50 indicates contraction.

Authorities said China has to cope with overcapacity in traditional manufacturing and emerging industries in the coming years. Otherwise, bankruptcy, debt and unemployment may cause a financial crisis.

"Overcapacity has exposed structural weaknesses in the process of China's industrialization," said Li Yan, director of industrial policy research with the Ministry of Industry and Information Technology (MIIT).

Easing the problem in the short-term by prohibiting excess production and overlapping investment will only ease the symptoms, but not cure the disease.

"Administrative regulations cultivate excess capacity," said Feng Fei, head of industrial economic research at the Development Research Center of the State Council, or China's cabinet.

He said that governments at all levels should recognize administrative influence on resources and production and the blind pursuit of economic growth, which largely determines how local officials are promoted.

Immoderate excess

China's latest large-scale governance of overcapacity happened after the world financial crisis in 2008, which was followed by a slack economic recovery and a new round of investment plans.

According to MIIT data, output totaling 720 million tonnes resulted in a loss of 28.92 billion yuan (4.67 billion U.S. dollars) for the country's iron and steel industry in 2012.

This was not a special case. In 2012, 93 percent of electrolytic aluminum enterprises suffered losses, considering the gap of 7 million tonnes between the industry's real output and capacity, MIIT said.

MIIT Minister Miao Wei regarded "moderate excess" as tolerable in economic growth, but warned of inappropriate overcapacity in some industries.

Feng pointed out that the phenomenon is becoming widespread.

Zhang Ping, former head of the National Development and Reform Commission (NDRC) , China's top economic planner, said the overcapacity problem is especially serious in traditional sectors like steel, cement, electrolytic aluminum, sheet glass and hard coke.

A capacity utilization of less than 70 percent is dangerous and could trigger vicious competition, Miao alerted.

A safe capacity utilization rate falls between 80 and 85 percent. Some industries in China have maintained a rate of just 70 to 75 percent.

China's struggling photovoltaic (PV) industry has had a capacity utilization rate of less than 60 percent.

After suffering from slumping demand and declining polysilicon prices, orders for Chinese PV equipment slumped 80 percent year on year in 2012, according to the China PV Industry Alliance.

Up to 90 percent of Chinese polysilicon makers halted production and 80 percent of solar panel producers shut down or sharply reduced output, the alliance said.

The situation became even worse following EU anti-dumping and anti-subsidy investigations targeting China's PV market.

Feng said the excess capacity problem cannot be solved by economic expansion, a fact that will make it more complicated to solve the problem.

Administrative tools

Li Yan attributed the overcapacity to declining demand, excessive investment and low-tech expansion.

"The problem is now rooted in challenges involving time, management and technology," he explained.

Li agreed with Feng in saying that local government performance-oriented investment is another cause of rebounding overcapacity.

Local governments are deeply involved in managing production, which can affect market operation.

"Government power causes similar choices to be made in different places," Feng said. "Vastly profitable sectors like land and mineral resources have led local governments to steer corporate investment."

Local governments are also in charge of approving projects, leading investors to prefer government-targeted sectors so as to ensure approval, Feng said.

Despite central government urges to curb excess capacity, local governments have not taken all the factors involved in industrial layout into consideration. Boosting the local GDP and employment are still prioritized, leading to repeated input for the same projects.

Regional protectionism and lagging systematic reform have sheltered many incompetent companies, hampering the market's function, analysts said.

Structural reform

The overcapacity problem may be solved through structural reform that boosts innovation and quality-oriented economic growth.

Li said the way local government performance is evaluated should be changed to fit the market and facilitate fair competition, as well as reduce administrative meddling.

Local governments should be banned from using direct stimulative measures to encourage investment, he said.

He also called for more transparent and stricter approval for land projects, leaving decision and risk for enterprisess to cope with.

Financial and taxation reform needs further implementation, in order to act as an efficient tool to restrain local investment while reducing pressure on the expenditures of local governments.

Necessary taxes for resources are expected to cover more products and sectors with high energy consumption, Li said.

Governments at all levels should create a healthy environment that allows the market to maintain itself and weed out unsustainable capacity, he said.

Li said less-controlled market operation and stricter approval for key projects can contribute to realizing greater market competition.

"More open market access, a stricter bankruptcy system and a smoother market pricing mechanism can help give full play to market competition," Feng added.