China Crackdown Drives Business Off the Books

An analysis by Michael Lelyveld
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A Chinese worker labors on a production line at a steel plant of Dongbei Special Steel Group Co., Ltd. in Dalian city, northeast China's Liaoning province, Jan. 30, 2014.
A Chinese worker labors on a production line at a steel plant of Dongbei Special Steel Group Co., Ltd. in Dalian city, northeast China's Liaoning province, Jan. 30, 2014.

The accuracy of China's economic estimates faces growing doubts as the government tries to cut industrial overcapacity, recent reports suggest.

The government's crackdown on excess and outmoded production has added new uncertainty to economic growth data as more business is forced off the official books.

Government-imposed lending limits on state-owned banks have been pushing targeted industries to rely increasingly on unregulated shadow banking, according to The Wall Street Journal and The New York Times.

Shadow banking loans, which also back local government debt, soared 43 percent last year to over 5.1 trillion yuan (U.S $851.7 billion), the Journal reported, citing estimates from the People's Bank of China (PBOC).

The result may be more unrecorded business activity, making it even harder to get reliable readings on China's economy after a series of contradictory signals.

"As with all black market activity, the question is what's the true growth rate of the economy," said Derek Scissors, resident scholar at the American Enterprise Institute in Washington.

Officially, China's gross domestic product, the broadest measure of economic activity, rose 7.7 percent last year, matching the growth rate of 2012 with the smallest expansion since 1999.

The figures have been subject to a host of questions, while world markets have reacted sharply to continuing signs of weakness in January as measured by purchasing manage index (PMI) reports. The PMI measures the rate of manufacturing growth in the economy.

Opposite directions

In recent weeks, China has issued a series of energy and economic results for 2013 that point in seemingly opposite directions, showing the slowest growth in oil demand in over two decades, according to Reuters,

but faster growth in power consumption than in 2012, the National Energy Administration (NEA) said.

But the government's campaign against industrial overcapacity may raise even greater uncertainties.

Last July, China's Ministry of Industry and Information Technology ordered over 1,400 companies in 19 industries to shut down outdated facilities and eliminate surplus production capacity by the end of 2013.

Production utilization in some of the affected industries like steel has dropped below 70 percent, state media said.

The ministry singled out major energy-consuming industries associated with construction and pollution, including steel, cement, electrolytic aluminum, plate glass and shipbuilding, the official Xinhua news agency reported.

Other targeted industries with significant overcapacity include copper and lead smelting, chemical fibers and papermaking, said the official English-language China Daily.

Some of the companies cited in reports last July said that cuts were already in the works.

But the effect on energy use and the environment remains open to question, judging by official data on the electricity industry for last year.

In January, the NEA reported that power consumption rose 7.5 percent last year, a faster pace than the 5.5-percent growth in 2012, even though industrial production grew less than in 2013.

The results may raise doubts about whether the targeted industries closed down their least efficient production lines in time for the year-end deadline.

More time

Scissors said the government directive may have been followed in some publicized cases, but decommissioning of industrial plants is likely to take more time.

In northern Hebei province, for example, the State Council, or cabinet, ordered the steel industry to cut 60 million tons of production capacity by 2017 as part of an anti-smog plan for Beijing. Local authorities plan to reduce steel output by 15 million tons this year, China Daily said.

Scissors said the government has been talking about overcapacity for the past decade, making it unlikely that the new crackdown will achieve instant results.

"It's way too fast for this to happen, so even if they reported it, I'd say they closed some plants for a month," Scissors said.

China's worsening problem with urban smog may also be visible evidence that heavy industry has yet to make significant cuts.

The electricity industry itself has continued to expand, although its biggest consumers have been ordered to pare back.

China's total installed power generation capacity reached 1.25 billion kilowatts (kW) by the end of 2013,

according to NEA figures, climbing 9.6 percent from the 1.14 billion kW reported for 2012. The increase was even greater than the 8-percent gain from the previous year.

Power industry yet to get word

The government may be serious this time about curbing overcapacity, but if so, the power industry has yet to get the word.

China added more new power generation last year than the total capacity of the United Kingdom or South Korea, according to figures from Bloomberg New Energy Finance, cited by Britain's The Guardian newspaper.

On the bright side, China installed a record amount of new solar power capacity, more than any other country in the world, but it also added more than three times as much in new coal-fired generation, The Guardian said.

The addition may be justified if China succeeds in taking older, dirtier coal-fired plants offline in the future, Scissors said, but the capacity numbers suggest that the shutdowns have not taken place yet.

Scissors said the central government is also likely to meet with resistance from state-owned enterprises (SOEs) that have been told to close inefficient plants, which provide employment and enjoy local support.

"The SOEs always want another SOE to contract," he said.

The question of compliance brings the issue back to shadow banking and estimates of economic growth.

Financed off the books

Since state-owned banks have been barred from lending to overcapacity industries, further operations can only be financed off the books.

"That way, it makes the local government happy because they're continuing to lend, and it makes the national government happy because it's not on the books," Scissors said.

The combination of seemingly contradictory data, the overcapacity campaign and the forces behind shadow banking may indicate that China's economy is actually growing faster than the 7.7-percent GDP growth rate.

"If there's more off-book activity, that would suggest a strengthening economy," said Scissors.

The theory may leave world markets increasingly in the dark as they react to economic reports from China, but it could help to explain some of the seeming contradictions in recent data, as well as the increase in urban smog.





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