Steel’s recent resurgence risks derailing industry reform

• A credit-fuelled rebound in China’s construction activity has breathed new life into the country’s beleaguered steel industry. The sector has been suffering for a number of years – as excess capacity, falling consumption and prices along with the inefficiencies of smaller scale mills hit industry profits. We believe that the recent recovery in construction is unsustainable, but the short term gains threaten to derail necessary reforms to the steel sector.

• At a fundamental level, little has changed in China’s property markets – with excess supply persisting in many locations. Instead we argue that policy changes that have relaxed purchase requirements, looser credit and the poor performance of alternative investment options (following the share market correction and crackdowns on shadow banking) have started to re-inflate the property bubble that had somewhat deflated across 2014 and 2015.

• Profitability for Chinese steel mills has improved, despite the recent run up in iron ore prices. Falling steel stocks have supported prices that have increased more rapidly than raw material costs. The result has been that while steel prices are around the highest levels since September 2014, steel profitability in late April was at its highest level since mid-2009.

• The sudden improvement in conditions in China’s steel sector – with profitability back to multi-year highs – could draw idle capacity back into production. Such a move could impact both the short term – through worsening trade relationships and further pollution – and the longer term, if it is allowed to derail much needed reform to the sector. Chinese authorities need to remain focused on the long term strategic benefits of reform.

For further details, please see the attached document:

• China Economic Update – May 2016 (PDF, 192KB)