Steel Collapse

China's steel industry is moving towards a trough. Last year, Steel Trade Lawsuits Explode; Banks' Unceasing Nightmare; Defendants Flee set the tone for a year with rising NPLs in the steel sector. Recently, charges of corruption have rocked the industry:

China Baosteel executive under investigation for corruption
A top executive of China's Baosteel Group, the parent of Baoshan Iron & Steel (600019.SS), is being investigated for "serious disciplinary violations", China's corruption watchdog said on Tuesday, as Beijing intensifies its war on deep-seated graft.

China's steel industry comes under the anti-corruption spotlight
A Deputy General Manager [Sun Wendong] at Wuhan Iron and Steel Co. has been detained on suspicion of accepting bribes, according to an announcement made by the listed firm to the Shanghai stock exchange yesterday evening.

...The steel industry has been one of the areas targeted with close to ten steel executives investigated since last year, according to a report in today's Beijing News.

Anti-corruption teams are stationed in the steel industry for two months, scheduled to finish at the end of April. Insiders were surprised at the two arrests because the men were widely considered low key, capable managers, with the WISCO executive pegged as a potential future CEO.

Corruption charges are the least of the industry's worries as rising debt levels indicate business conditions are worsening. An undercurrent of default is raging as short term debt hit recently hit ¥980 billion, or 74% of the industry's ¥1.33 trillion in bank loans.

Previous government efforts to rescue the industry have failed. Reorganizations were supposed to help, but local governments each have an incentive to fight for their local mills and the central government fears economic instability. One proposed restructuring that would merge WISCO and Liuzhou Steel is 10 years in the making. An "Action Plan" was put together in 2012 that would allow the market to play a decisive role in allocating resources, strengthen the position of companies in the industry and create a competitive environment.

The 2012 Action Plan wasn't only for steel. The government was to halt approval of iron, aluminum, cement, plate glass and other industrial projects. For steel, the government wanted to leave about 300 companies. This number confused the public, since the market was supposed to be playing a role. Why did the government delineate the number of desired firms? The number comes from a government study which found 300 firms is appropriate during "normal conditions." The 300 firms accounted for about 90% of China's steel production.

The reason for the government's failure to tame the steel industry became crystal clear in 2014, when credit guarantees became a major issue. As with other industries, mutual credit guarantees form a web of interlocking liability. If one steel mill is shuttered, it sets off a chain reaction that shutters several more. In March 2014, Haixin Steel ceased operations with ¥20 billion in debt owed to 33 different lenders. Disaster fell on other steel and energy companies that had guaranteed Haixin's debt. This daisy chain of mutual guarantees tied the government's hands, restricting their actions for fear of setting off more bankruptcies.

If ¥20 billion can wreak havoc on the industry, imagine the problem facing the government today. In addition to the ¥1.3 trillion in bank loans, much of it short term, the industry's top 80 firms also owe ¥1.7 trillion in short-term high interest loans. Firms are borrowing to repay old debt, for instance a Xinjian unit of Baosteel saw its short-term debt climb 13.3% last year, even as long-term debt fell 29%. This increases the risk of default should credit conditions tighten.

Amid this looming chaos, a new three-year action plan is being developed for steel, plus a new 5-year plan and long-term industrial policies. If the government failed when debt levels were much lower and the economy was growing much faster, what are the odds of success today?

EEO: 钢的“底”

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