Chinese commodity producers, much like the nation’s industrial sector, have endured a tough period in recent years, undermined by tumbling commodity prices, slowing internal demand, fierce competition from lower-cost offshore producers and, in many instances, enormous debts.
Fears have grown over the outlook for the sector, particularly given few see the factors that led to the current malaise being reversed anytime soon.
Loss-making, already rife, could grow even further, particularly should the government delay reforms to curb overcapacity in the sector.
The chart below, supplied by Vivek Dhar, a mining and commodities analyst at the Commonwealth Bank, demonstrates just how dire conditions have become for firms within the sector.
It looks at the current percentage of loss-making enterprises as estimated by the bank, lspecifically at coal, energy, ferrous and non-ferrous metals producers.
Clearly the trend is rising, particularly for energy producers, with the recent rebound in global commodity prices barely registering when it comes reducing the number of firms presently running at a loss.
It’s a grim outlook, made even worse by the factors keeping many uneconomic firms in operation.
“These loss-making companies remain operational largely due to local government interest to maintain employment. Banks too are reluctant to declare nonperforming loans, helping keep these enterprises online,” says Dhar.
“More importantly, the structural increase in loss-making commodity production over the last few years underscores the need for systemic supply-side reform. We believe these changes are required sooner rather than later given the importance of productivity in China’s transition to a services-based economy.”
Adding to the urgency for reform, Dhar, like many others, believes that the rebound in commodity prices seen recently — largely due to Chinese policymakers turning on the stimulus taps to ramp up infrastructure and residential construction (which given overcapacity concerns in the latter raises additional concerns) — will likely reverse in the second half of the year.
“We forecast most commodity prices will peak this quarter and bottom by mid-2017 premised on China’s stimulus measures fading in 2H16 due to the urgency for structural reform.”
That’s what the markets are waiting for — meaningful reform — rather than encouraging marginal producers to restart operations due to what will likely prove to be a short term spike in commodity prices.
Reforms will impact millions of people, that is unquestionable. Equally so, no one thinks that it will be an easy task, with the potential for economic and social policy missteps likely to exist throughout.
However, just as few disagree that it won’t be easy, an equal number know that continuing on the current path will almost certainly lead to an even harder task, accompanied by even greater risks as a consequence.