China

The World Bank released a damning report on China’s banking sector this week entitled “China Economic Update.”

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In unusually forthright language, the bank said Beijing urgently needs to overhaul the government-run banking system that subsidizes state industry at the expense of savers and provides little support for entrepreneurs and emerging industries encouraging an unregulated shadow banking sector that, in turn, creates risks.

Government as Both Bank Owner and Regulator

According to US News & World Report, quoting sections of the bank report, Beijing needs to separate its roles as owner of China’s banks, regulator and strategic planner and to construct a system that channels more lending to productive industries and manages risks better. The Chinese state has formal ownership of 65% of commercial bank assets and de facto control of 95% of assets, according to the report. It said that while some other countries have state-owned banks, by comparison using the same calculation that figure is 74% in India and 40% or so in Russia neither of which a paradigms of free enterprise, China’s entire financial system is government-dominated.

“Instead of promoting the foundations for sound financial development, the state has interfered extensively and directly in allocating resources,” the World Bank said, adding reducing the “unique and distorted role of the state” in banking and the wider financial sector was crucial, according to a further report on the World Bank report in the UK BusinessInsider.

How the China’s Banking System Creates More Debt

The article accused China of, “Wasteful investment, over-indebtedness, and a weakly regulated shadow-banking system.”

In some cases, it added, authorities were simultaneously owners, regulators and customers of banks.

The bank says further growth is at risk if these distortions in the banking system are not addressed and after raising the same concerns in their 2012 report said risks to the system had actually increased in the interim. China itself has set a target of about 7.0% growth in GDP for this year, a figure the bank broadly accepts saying it should be similar next year before slowing further in 2017 to about 6.9%.

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Crude steel output will shrink as much as 2% this year, according to Bloomberg reporting data from the China Iron & Steel Association.

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That’s lower than the group’s March estimate of a 1.1% decline and would be the first contraction since at least 1990 the paper says. Crude steel output will shrink to 807 million metric tons this year from 823 mmt in 2014, according to the steel association as producers shut capacity.

Source Bloomberg

Source: Bloomberg

The reduction is being driven by a number of factors but profitability, or the lack of it, seems to be the greatest. Iron ore prices have risen by 40% in just two months as low port stocks at China’s ports suggested a tighter supply market Reuters reports. The market is speculating that producers and traders are holding back supplies in an effort to push up prices but top producer Rio Tinto Group pours cold water on that theory saying they are not in the business of playing the market month by month and supply is plentiful.

Supply Up, Demand Down

The firm will likely ship 350 mmt this year, up from 300 mmt last year. Lower seaborne iron ore prices in Q1 appear to have finally taken their toll on domestic iron ore producers, though, with production dropping 11% in the first five months of 2015 as higher cost producers have been squeezed out.

Source: Bloomberg

Source: Bloomberg

Few are expecting iron ore prices to remain elevated with steel production falling and supply plentiful, iron ore prices are likely to come down from here. Steel reinforcement bar (rebar), has fallen 14% the current quarter to 2,265 CNY per mt ($365/ton) as of Friday, the lowest since at least 2003, according to data from Beijing Antaike quoted by Bloomberg.

Construction Falling

The construction sector has been hit particularly hard, as evidenced by the amount of land purchased for real estate development falling 31% in the first five months of this year and new construction starts slumping 16%, according to the National Bureau of Statistics.

The paper quotes Goldman Sachs saying about 35% of China’s steel demand is related to housing and construction-related activity. Led by construction, China’s apparent steel demand fell 4% to 302 mmt during the first five months of 2015, a reversal from 3% growth in 2014. Meanwhile, exports have surged further underlying the excess domestic inventory position.

China exported a record 10.3 mmt in January and shipments in the first five months of the year were 28% higher than the same period in 2014. At that rate, the country ships out more than any other single country produces, according to data from the World Steel Association; an untenable situation in the long run prompting widespread anti-dumping actions in Europe and the Americas.

No Quick Chinese Turnaround

To what extent profitability will play a role on China’s steel production in H2 remains to be seen. Most expect iron ore prices to fall, reducing supply-side cost pressures for steel producers even if it does little for demand. Reuters quotes Julius Baer estimates of $40 per mt as a possible low point for iron ore and Citi seems to agree saying, “We expect iron ore prices to reverse sharply and decline over the coming months,” averaging $51/mt this year and $40/mt in 2016.

While a few boosters are looking to infrastructure, such as Russian-Chinese pipeline projects and electrification as future drivers of increased steel demand, most are not seeing any increase in demand anytime soon.

Indeed, Li Xinchuang, CISA’s deputy secretary-general, is quoted by Bloomberg as saying in an interview this week: “Low prices will be with us for a long time. So will tepid demand and zero growth, or even contraction, in output.”

That doesn’t bode well for the rest of the world seeing high levels of Chinese steel exports, even when anti-dumping cases are successful in blocking direct Chinese steel exports to a particular market, there is still the effect of diverting that supply to other markets and driving down global steel prices as a result.

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Sources told Reuters that steelmakers in China were selling their products below cost and President Obama hosted a picnic at the White House with members of Congress ahead of a key trade vote.

Confirming What We Already Knew

Some Chinese steelmakers are selling their products abroad at a loss, traders and a producer told Reuters, as a group of global industry bodies urged governments to take action over rising shipments from China.

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Chinese mills had sold steel overseas at a loss of up to 200 CNY ($32) a metric ton and cut the export price of hot-rolled coil by 5% to $340-$350 per mt, free-on-board basis, this week compared to last week, traders and a producer in Hebei, China’s top steel-producing province told the news service.

These mills were also selling at a loss to the domestic market, the sources said.

“The domestic market is too weak to consume high output and our prices are competitive, so some mills are still keen to step up exports, hoping to ease high inventories and maintain market share,” said a senior official at a privately owned mill in Hebei.

Preesident Has Picnic With Lawmakers Ahead of Trade Re-Vote

President Obama hosted members of Congress yesterday for the congressional picnic amid a fierce trade debate on Capitol Hill.

This year’s gathering took place before the House was expected to hold a vote today to revive the president’s stalled trade agenda, and less than one week after Democrats killed a key part of the legislative package.

House Minority Leader Nancy Pelosi (D-Calif.) was in attendance at the picnic. The president has not spoken with her personally since she led the Democratic revolt against the trade bills.

The event is seen as an opportunity for the president to get face time with lawmakers in a low-pressure setting. That could prove to be important for Obama with the House set for a re-vote on fast-track trade authority and a measure to provide aid to US workers displaced by international trade.

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China is planning to replace business taxes with a revamped value-added tax that may expand three crucial sectors next month, according to a report Thursday from the state-run Economic Information Daily.

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A revamped VAT in China will affect imports and exports.

The program is an extension of a pilot project in Shanghai.

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The Ministry of Finance laid out a reform plan involving real-estate, finance and consumer services that it expects to put into effect in July, the report said. Under the blueprint, an 11% tax will be levied on property and construction companies, while a 6% rate will be imposed on financial and consumer-service industries. China started a trial run of VAT reform in 2012, aiming to reduce double taxation on companies and reduce their overall tax burdens. If fully implemented in the entire country, the VAT reform could lower taxes as a whole by 900 billion CNY ($144 billion). The Ministry is under pressure to increase consumer spending and increase growth.

A VAT taxes the difference between the sale price charged to a customer, minus the cost of materials and other taxable inputs. It is collected at the point of sale, making it, theoretically, easier to collect than individual and corporate taxes.

The Ministry of Finance already recently slashed tariffs by 50% for 14 categories of products including cosmetics, shoes and diapers. The reduction in taxation was intended to get Chinese consumers to spend more and give them access to more international brands and products.

One industry that would not welcome the new structure is China’s financial sector. Scrapping the old VAT and replacing it with the new 11% and 6% rates of taxation would likely raise the net tax burden of Chinese financial firms. There is currently a 5% corporate tax on the sector. A new VAT would also affect firms in the US taking delivery of exported Chinese goods, such as steel. China removed export tax rebates on boron-containing steels to dissuade producers from simply shifting excess production onto export markets back in January, but removing the rebate didn’t really make much of a dent in Chinese exports. It’s still unclear how the new rates would effect exports.

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The imposition of anti-dumping duties by the Indian government should encourage US authorities who have been asked to enforce a similar move. The suit filed by six US companies concerns corrosion-resistant steel, a type of coated steel used in automobile and construction industries. The US has been witnessing an unprecedented flood of imports in the last one year or so.

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As reported by MetalMiner last month, the US steel industry is suffering because the imports hit a record 34% of market share, according to the American Iron and Steel Institute (AISI).

The US slapped duties on imports of steel used in the energy industry from South Korea and five other countries last year but, evidently, those tariffs did not have the desired effect. The AISI in its press briefing last month, asked the US Government to first enforce existing trade laws which would be an immense help to the steel industry.

In India, steel imports had increased to 0.91 million metric tons this May, an increase of 58% as compared to the same month’s figure last year. As compared to April 2015, the import rate was up by about 20 mt, according to a report by the Ministry of Steel.

Many analysts said the Indian stainless steel industry started resembling a sick industry, as cheap imports were leading to a situation of under-utilization of installed capacities. The local industry hopes the anti-dumping duties will send out a clear signal to those sending in cheap imports, and lead to a resurgence in India’s steel sector.

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The author, Sohrab Darabshaw, contributes an Indian perspective on industrial metals markets to MetalMiner.

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Indian exports of aluminum have been on the rise for some time now, since local use has fallen because of the slow economy prior to the election of the new Modi government last May.

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Aluminum from Hindalco’s Mahan unit in Madhya Pradesh province is being shipped to Japan and South Korea, the US, and some African nations, too. A surge in demand for aluminum by the automobile industry and for use in can sheets were said to be the main drivers of the exports.

Strong Export Demand

India was already a net exporter of aluminum even before this surge happened.

India has a smelting capacity of over 36 million metric tons. Last year, its manufacturers produced about 28 million mt of the metal, while this year, analysts say, the figure could go even higher. However, with Chinese imports are affecting domestic consumption. The question on everyone’s mind is – who’s buying?

New capacity is being added in the face of slow growth in domestic demand. Chinese producers are simply undercutting local prices.

Chinese Imports Not Stopping Production

Some Indian aluminum producers remain undaunted by the imports. One such optimistic person is Debu Bhattacharya, managing director, Hindalco, who told the Hindustan Times recently that the phenomenon of Chinese goods coming into the Indian market would be “short-lived.” He said aluminum’s wide applications would ensure a strong outlook for the metal in the coming months.

Hindalco is one of India’s largest aluminum producers, and has posted aluminum sales growth of 14% on the fiscal year that ended in March 2015 due to higher production at its two new smelters — Mahan Aluminum and Aditya Aluminum.

Independent research agency CRU, too, seems to be on the side of Indian producers. It said in a recent forecast that aluminum production would rise throughout this year despite the announced closure of AlcoaBHP Billiton‘s Sao Luis plant in Brazil. The global production estimate for Indian aluminum is high, betting on the two Hindalco smelters and Balco’s Korba all seeing production rise this year.

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The author, Sohrab Darabshaw, contributes an Indian perspective on industrial metals markets to MetalMiner.

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China is doubling down on its export practices and encouraging its steelmakers to fight anti-dumping actions by foreign nations. Alcoa recently won a supply contract for a major smartphone manufacturer.

China Urges Steel Sector to Fight Dumping Actions

Beijing urged Chinese steel companies, collectively the largest in the world, to launch lawsuits to defend themselves against a rising tide of international trade complaints, including those from the US, its commerce ministry said.

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“We encourage Chinese steelmakers and related businesses to actively participate in countersuits, and protect their legitimate interests according to World Trade Organization rules,” the ministry said this week.

The ministry’s stance comes as rising Chinese steel exports have run into resistance from competitors at the destinations of its shipments.

Six steelmakers with major US operations, including U.S. Steel Corp. and ArcelorMittal USA, filed a trade complaint on Wednesday seeking punitive tariffs for alleged unfair pricing of imported steel from five countries including China. The suit concerns Chinese exports of corrosion-resistant steel used in the automotive and construction industries.

Samsung Chooses Alcoa

Alcoa Inc. said on Thursday it is supplying aerospace-grade aluminum to Samsung Electronics Co. Ltd. for its Galaxy S6 and S6 edge models, enabling the smartphone maker to produce more durable and sleeker phones.

Phones made with 6013 Alcoa Power Plate, which is 70% stronger than standard aluminum are available now globally, Alcoa said.

This latest announcement fits New York-based Alcoa’s strategy of moving away from costly traditional smelting and refining toward more value-added businesses such as automotive and aerospace.

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That China uses overseas investment as a tool for political as well as economic advancement is no surprise to anyone.

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Beijing has come under criticism in the past for investing in places like Zimbabwe and Sudan regardless of the human rights flavor of the regime in power, but such criticism is like water off a ducks back. China is in it for China’s gain and cares little for what others may say.

It will be intriguing looking back 10 years from now to see what some of these emerging markets have given away to China in return for much-needed investment. Beijing is not stupid and exacts a price for it’s infrastructure and development investments in in the form of ownership of mines and agricultural assets useful for their industry and food supplies.

A Tale of Two Centuries

Many would argue this is no different from western nations’ exploitation of African and South American countries in the last century, but you would certainly hope the recipients had learned from such experiences. One advantage China wrings from such deals is often the supply of materials and equipment in addition to expertise and finance.

In many cases even the workforce is supplied, too, in the construction of infrastructure projects. In the face of growing global alarm at rising Chinese steel and aluminum exports, recipients of direct investments can hardly complain about the provider supplying materials, so major road, rail and power projects provide an opportunity for substantial Chinese exports.

China in Brazil

This appears to be one of the major attractions in investment decisions made this month in Brazil following Premier Li Keqiang’s visit to Brazil, Columbia, Peru and Chile. Li announced billions of dollars of investments while there last week, potentially up to some $50 billion to Brazil alone according to Reuters, on top of a similar amount in other South American countries.

In return, Brazil has gained not just desperately needed finance and investment but concessions for exports such as a lifting of the 2012 beef ban following an outbreak of mad cow among Brazil’s herds. According to the Guardian newspaper, trade between China and Latin America as a whole exploded from barely $10 billion in 2000 to $255.5 billion in 2012, while Chinese-Brazilian trade mushroomed from $6.5 billion in 2003 to $83.3 billion in 2012.

Although China is just the 12th-largest investor in Brazil, it is Brazil’s largest export market, mostly of raw materials, a situation Brazil would dearly like to change if it were only competitive when it comes to manufactured goods. One area of expertise is aircraft, part of the recent deal is a $1.3 billion sale of 22 Brazilian Embraer commercial jets to China’s Tianjin Airlines.

Anyone familiar with the trials Vale SA has been going through gaining agreement to use its fleet of new Valemax super ore carriers docking at Chinese ports, will not be surprised to hear the iron ore producer has finally caved in and sold four of the vessels to China Merchants Energy Shipping Co. Ltd. for an undisclosed sum. It was only ever about China having a role in that trade.

Construction has started on a 2,800-kilometer transmission line by China’s State Grid Corp., the world’s largest utility to link the Belo Monte hydroelectric dam under construction in the Amazon to the industrial state of Sao Paulo whilst much talk is being made of a possible railway from the southeastern Brazilian port of Santos more than 3,500 km (2,200 miles) to the Peruvian Pacific port of Ilo.

For Brazil, it offers the chance to avoid the Panama Canal and, for China, lower-cost access to Brazil’s markets via the Pacific in addition to the steel, rolling stock and associated equipment that would no doubt be part of the deal.

China has become adept at, as the Japanese before them, combining finance, expertise and material supply in their overseas investments. State driven and financed, they can afford to play the long game and maximize political and well as commercial aims. In that regard, cash-strapped but economically more developed South America has much more potential than Africa did. Expect more of the same in the years ahead as China seeks to both spread its influence and put those massive reserves to use abroad.

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China has changed its tack on steel exports.

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In previous years it has sought a more conciliatory position to complaints by trade partners, a WSJ article says in the past CISA, China’s steel trade association, has sought to persuade local steel mills to curb exports and show restraint but this year, in the face of an unprecedented surge in volumes, Ministry of Commerce spokesman Shen Danyang is quoted as taking a much more defensive line saying the rise in steel exports is due to higher global demand and is a result of Chinese steel products having strong “export competitiveness.”

Chinese Now Say Exports ‘Justifiable’

Set against a backdrop of the EU’s recent investigation into dumping of cold-rolled coil from China and Russia, Shen is reported to have come out fighting, saying “Under such circumstances (demand and competitive pricing), I feel that it’s quite normal for Chinese steel exports to these countries to be rising, and it’s quite justifiable.”

Meanwhile, the WSJ adds the US, Australia and South Korea have also signaled that they are lining up support for trade action against Chinese steel exports, which rose by 50.5% last year to a record 93.8 million metric tons and have continued at a high level this year.

Chinese steel mills are on a roll according to data reported by the WSJ. Between September last year and January this year, the volume of China’s outbound steel shipments each month shattered the preceding month’s record. While in the first four months of 2015, steel exports were 32.7% higher than a year earlier.

The reason isn’t hard to find, domestic steel prices in China have been on a slide as demand has collapsed. According to a Bloomberg article Infrastructure and construction together account for about two thirds of China’s steel demand, citing HSBC research, and construction is slow as housing prices fall there.

Construction Slump Continues

New home prices slid in 69 of the 70 cities tracked by the government in April from a year earlier, according to National Bureau of Statistics data. As a result construction-related steel prices such as rebar have hit their lowest level since 2003.

What’s worse is the peak buying period for the construction sector is now in the past and demand would fall for seasonal reasons even if construction was strong. According to Reuters, prices have dropped 13% so far this year with the most-traded rebar futures contract for October settlement on the Shanghai Futures Exchange down to 2,355 yuan ($379.71) per ton, while MetalMiner’s own China tracking service has recorded a 16% fall in domestic steel prices this year from 2,810 yuan/mt at the beginning of the year to 2,340 yuan now.

What is Chinese ‘Cost?’

Such a slump in prices has aided steel mills in their drive to dump excess capacity overseas. Is it below cost? What is the cost price in China? what are a mill’s true costs for state enterprises that receive all kinds of support both at the regional and state level?

Steel mills are under pressure to close excess capacity but so far the result has been limited, excess capacity is being offered for export rather than any real attempt made to exercise market discipline and shutter plants. The trend is likely to get worse before it gets better, particularly if Beijing’s hard line continues, we can expect more trade disputes and possibly lower prices in the year ahead.

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According to a report, crude-steel output in China dropped 1.3% to 270.07 million metric tons in the first four months of 2015 as compared to the same period in 2014. The World Steel Association has forecast that China will end up using far less steel this year and maybe even the next. Which again means more supply and far less demand.

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The report quoted Alan Chirgwin, BHP Billiton iron ore marketing vice president, as saying steel supply was expected to rise by about 110 million metric tons this year, exceeding demand growth by around 40 mmt.

Yet this has not fazed Rio Tinto Group, for example, which recently announced it would continue with its plan to produce iron ore at full capacity despite the fall in prices. While BHP and Brazil’s Vale SA have, for now, stepped on the brakes vis-à-vis their medium-term plans, team Rio, on the other hand, thinks reducing production costs will help it hang on to its lead…and profits.

Betting on a Comeback

Rio Tinto sees China coming back with renewed vigor and driving global iron ore demand through 2030.

Where does that leave India? So far as iron ore or even steel consumption is concerned, China is miles ahead of India, even in the fatigued condition it finds itself today. India, as reported by MetalMiner, drew a blank for about two years due to a court-imposed ban on ore mining, which left its steel companies at the mercy of imports, something that they continue to rely on even today.

That had also affected its iron ore exports, especially from the ore-rich provinces of Goa and Odisha. India’s iron ore imports went up dramatically to a record 6.76 million tons in the first 7 months of the 2014-15 fiscal year. Once, the country was the third-largest supplier of iron ore to the world, but, because of the export duty and a national mining ban, it had turned into an importer.

Analysts predict India was likely to remain a net importer of iron ore in 2015-16 as well, no thanks to the continued drop in falling international rates. The only silver lining, claimed analysts, could be that due to the resumption in the domestic production of iron ore, the quantity of imports may not be as high as the last fiscal year.

Captive Market

India’s steel companies do not have captive mines, so they have to get their average 95 mmt a year of iron ore from elsewhere. With international price of ore hovering today at about $50 per mt for high-grade ore, it is too attractive a deal for Indian steel mills to be passed on. As reference points, last year, iron ore imports happened when rates had touched $90 per mt.

In all this, Australia, a country that sells about 80% of its ore to China, sits in a happy position. While it hopes that the recent cuts in interest rates will revive the Chinese economy, and thus its demand for iron ore and coking coke, it is also looking increasingly to India to pick up its stock. Last year, for example, as reported by MetalMiner Australia had approved Adani Group’s approximate $15.5-billion (AUS $16.5 billion) Carmichael coal project in Queensland that could yield up to 60 million mt of coal per year. That was just the beginning. For the Aussies, if the dragon’s appetite for iron ore and coking coal is satiated, the hungry tiger is always lurking in the background.

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