Recent Developments in China’s Steel and Financial Sector: Implications for the UK
The recent visit of Xi Jinping to the UK raised considerable discussion about the threats overcapacity in China’s steel sector pose to the UK and the opportunities offered by plans to accelerate the liberalisation of China’s capital account. In this talk I will show how current developments in China are likely to have a significant influence on both of these areas. Two points are important:
Although steel is an industry from which the UK has retreated from, a lack of consolidation in Chinese steel mills is having an effect on steel employment in the UK. This is mostly due to the type of steel China produces and the way Chinese steel production is integrated into global supply chains.
In the financial sector the internationalisation of Chinese currency the RMB will offer opportunities to the UK’s financial sector but these opportunities may not materialise for some time.
Uniting these two issues is the year 2020. This is the date the Chinese government has set as a target for capital account liberalisation and for the completion of ownership reform in the state sector. It should also be noted that this is also the date by which the Chinese government believes China will reach the status of a moderately prosperous economy
The Steel Sector
Chinese officials have been aware for some time of the problems facing its steel industry. Officials have grappled with the problem of overcapacity since 2003. Consolidation in the sector has proved painfully slow, the consequences of which are now apparent. In late October 2015, officials from China’s National Development and Reform Commission asked investors to postpone redeeming bonds in a large state-owned steel producer and trader. Officials have also realised that foreign investment in the sector has not led to faster upgrading or consolidation in the domestic sector, but has allowed large international steel companies gain a considerable foothold in China.
Many of the problems of steel are a legacy of central planning with its emphasis on high volumes and low attention to quality:
Efforts to close down or deny finance to steel industry and close down smaller units under a certain capacity began in 2003/04
By the end of 2013 there were some 11,034 ferrous metal smelting units – about 400 of which are state-owned
Low iron content in domestic ores (30%) makes upgrading extremely difficult and has created a dependence of imported Brazilian and Australian ores of higher iron content.
Continued reliance on coal for smelting of ferrous metals – over 50 percent of energy consumption in smelting comes from coal
There is evidence that China’s steel output has peaked. Crude steel production for September 2015 was 66.1 Mt, down by 3.0% compared to September 2014. Per capita steel output appears to have peaked in 2013 at 573kgs/capita compared to 270 kg/capita in 2005. Efforts to reform the state sector have accelerated in recent months with price liberalisation planned for key state sectors by 2017 and ownership reforms by 2020.
It is worth noting that these targets have in the past proved very difficult to meet. Rationalisation in China’s steel industry would require a significant loss of employment in both state and private steel mills. The last wave of employment reductions in the 1990s under the leadership of Zhu Rongji had a devastating effect on many former industrial provinces. A slowing economy and an edging up of urban unemployment (September, 2015) lessens the likelihood of such consolidation in the near term.
Developments in China’s Financial Sector
Of particular importance to the UK is the commitment to make the Yuan freely tradeable and usable by 2020. This will require a roll-back in restrictions on capital account transactions and a policy that is supportive of overseas investment, especially in the non-state sector, as a means of easing capital account imbalances.
There have however specific challenges in meeting these targets:
Recent data point to a continued fall in China’s foreign currency reserves. These stood at US$3.51 trillion at the end of September compared to a peak of 3.99 trillion in June 2014.
A slowdown in the growth of social financing (China’s preferred monetary aggregate) for the first three quarters of 2015 comparted to the same period in 2014 and a contraction in off-balance sheet lending is likely to increase caution
A further reduction in interest rates by 0.25 percentage points and cuts to the bank reserve requirement ratio by 0.5 percentage points indicates that China’s central bank remains concerned about the cost and availability of credit
A continued reliance on loan finance indicates limited progress in creating more diversified financial markets
Double digit increases in RMB lending no longer appear to be having a big effect on employment creation.
Despite these challenges, reform of the financial system remains a key part of the NDRC’s annual economic reform plan released in April of this year. This was echoed in a pledge by the governor of the People’s Bank in March 2015 to accelerate market reforms and the usual commitments to open up of capital markets make the Yuan convertible on the capital account.
While significant progress has been made in terms of liberalising the interest rate, officials remain frustrated with the administrative mentality of commercial banks. The real problem continues to be the slow progress in reforming the structure of capital markets.
Prospects for the UK
Rapid economic growth has increased the costs of capital controls. Controls act as a barrier to such policy objectives as the internationalisation of the RMB and the targets to raise the share of services in economic activity. The UK is well positioned to gain from these changes. But it has been slow to move. China has been promoting the wider the use of RMB in trade settlement and investment since 2009.
The allocation of an 80 billion yuan quota under the Renminbi Qualified Foreign Institutional Investor (RQFII) scheme alongside the permission for Chinese banks to establish branches in the UK represents a tentative first step. The preference among Chinese banks for branch status indicates a strategic wish for greater operational independence. A slowdown in loan growth in China and the prospect of further interest rate reform in the Chinese market has constrained domestic growth opportunities. In contrast, state banks have been aggressively growing their loan books in overseas.
One of the biggest threats to the UK in this area is competition from other financial centres. These include Singapore and Taiwan as well as domestic Chinese competitors such as Shanghai and Qianhai (Shenzhen’s financial centre). The lessons of Hong Kong may be instructive in this regard. Hong Kong consistently ranks as one of the world best places to do business. It has maintained this position despite the well-publicised target of turning Shanghai into a global RMB settlement centre. Although Hong Kong is the main offshore centre for RMB deposits, Hong Kong’s emergence was built not on the sophisticated financial products it could offer, rather on the more prosaic function of trade settlement. Hong Kong also offers a window on the likely challenges that come with an offshore market for what remains a non-convertible currency.