China Politics Weekly No. 104- August 22, 2016

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Supply-side reforms move into implementation phase…

After two weeks off, the top leaders got back to work last week. The State Council’s first executive meeting since the break focused on cutting overcapacity, identified as the number one priority within the current supply-side agenda. Local governments are currently behind on their capacity reduction targets, so the State Council is sending out inspection teams over the next few weeks to oversee implementation.

I’d put money on the government meeting its targets for steel and coal capacity reduction this year, which are 45 MT and 250 MT, respectively. The State Council said that they would set up a “reward and punishment mechanism”. Central funds for worker re-training and resettlement have already been tied to meeting targets. The combination of high-level support and fiscal incentives should ensure successful implementation.

…but achieve little

That the government will finally meet its overcapacity target is encouraging, especially since the most previous efforts to tackle the problem in 2009 and 2013 were utter failures. However, the progress made this time will not be enough to fundamentally solve the problem. Even aggressive implementation of the government’s plans over the next three years would barely bring utilization rates in the coal and steel sectors above 70%, meaning that overcapacity be slightly less severe, but still present.

What’s more, closures are not necessarily removing the most inefficient capacity. It is the government – not markets – that is the principal arbiter of which firms stay and which firms go, meaning that political considerations are primary, and economic ones are secondary. Efficiency gains from reducing capacity will thus be muted.

Current efforts are better than nothing, but far from great.