China facing complex problems in steel sector development

Zhu Qiwen, China Daily, Asia News Network, Beijing

China's steel companies cannot expect a more solid time as the ravenous domestic market continues to consume more than they can provide.

The ongoing investment rush in the sector indicates that many of them are over confident. But such optimism, in a sense, is well grounded.

China has been the world's largest steel producer for seven consecutive years since its annual output exceeded 100 million tons in 1996.

Last year, the domestic output hit a record high of 182 million tons, an increase of 30 million tons over 2001. Meanwhile, the country's growing appetite outstripped domestic production capacity last year by digesting about 211 million tons of steel products, accounting for a quarter of global consumption.

That, in turn, made the country the world's top steel importer. In the first half this year, steel output further jumped to 103 million tons, bringing a total profit of 20 billion yuan (US$2.4 billion).

Robust demand has driven up prices since the first quarter last year. The monthly average price of steel products rose 22.84 percent to 2,463 yuan ($297.8) per ton in December last year, according to the China Iron and Steel Association.

Striking profit margins have turned the steel sector into a hotbed for investment. A nationwide investment boom in the industry is gathering steam in the form of an explosive growth in production capacity.

Statistics show investment in the steel industry rocketed beyond an increase of 153.7 percent for the first quarter. The upward trend of steel prices in China is also helping to pull in investment.

The forecast earlier this year by the former State Economic and Trade Commission that domestic demand is set to reach 215 million tons for 2003 is also underpinning investment decisions.

In addition, at a national industrial conference held last week, experts from the Development Research Center under the State Council, again, stressed that the sector will witness a period of rapid development in the coming two or three decades.

This sort of prediction clearly sits square with the country's ambitious goal to quadruple its economy by 2020.

However, while appreciating the growth momentum it has added to the national economy, the authorities have kept a cautious watch on the glowing steel sector.

The skyrocketing prices have hindered development of other sectors in the economy. And more worrying is that the breakneck expansion of the production capacity can undermine the sustainable development of the steel industry as well as the whole economy.

In fact, the State Development and Reform Commission (SDRC), the country's macroeconomic watchdog, had already warned in April that the sector had become too hot.

Steel prices have shot up so drastically and increased the costs in other sectors so harshly that six subsidiary companies of the China State Shipbuilding Corp submitted a joint letter in late March to the SDRC, calling for the government to "take effective measures to make the prices of steel reasonable."

Fortunately, the SDRC was wise enough to refuse the temptation of administrative measures to rein in the prices.

Since the current pricing trend is a natural result of strong market demand, administrative interference will not help match up supply and demand.

Some steel-consuming manufacturers blame steel companies for their short memories -- domestic prices hit rock bottom two years ago and domestic orders were critical for their survival.

But it seems what domestic steel companies really lack is not a good memory but foresight.

The investment boom is, to a large extent, based on current market conditions instead of on the overall economic picture.

Though investors' enthusiasm is justified by the brisk market, an analysis of the underlying causes behind the market boom shows that the price to sustain it might be too high.

One driving force is the country's massive investment projects funded by State bonds since 1998. The government has issued bonds worth 660 billion yuan ($79.7 billion) to boost long-term construction. The campaign has propelled not only the consumption of steel but also investment in the sector.

But with the country's fiscal deficit expanded, a gradual phase-out of pro-active fiscal policy is only a matter of time.

The other reason is the safeguard measures the country has adopted for iron and steel products. The U.S. government imposed steel tariffs of up to 30 percent in March 2002 to protect its iron and steel industry. The counter measures China took to protect the legal interests of the domestic iron and steel industry, ironically, turned out to be a catalyst for domestic price hikes.

As the U.S. safeguard measures were recently ruled against by the World Trade Organization, global steel production will likely rebound following the destruction of the protectionist barriers.

The environment burden the investment boom imposes on the country is another problem investors have not attached due importance to.

To develop local economies, some local governments have given green lights to steel-related investment projects regardless of local water resources. And to rake in quick returns, many investors want to go into operation as soon as possible to take advantage of the current market conditions, instead of adopting advanced and energy-saving technologies.

All these problems can hardly be addressed by a single steel company. Therefore, the onus is upon the policy-makers to figure out an effective approach to fine tune -- if not cool -- the investment frenzy.

The government should weigh the pros and cons very carefully before taking action, especially as the economy has just survived the impact of severe acute respiratory syndrome.

The SDRC recently listed the steel industry as one of four overheated sectors that requires investment control. The authorities' move may be unwelcome to investors but letting go the opportunity to douse the glowing steel sector will be expensive both economically and environmentally.