As China urges businesses to get back to work, it is relying on industries like autos and steel with record high inventories of unsold goods that may drag on an economic recovery.
Officials in the steel industry have voiced confidence in a rapid return to high production levels despite the negative effects of the coronavirus slump.
"Many steel companies will slash output as inventories pile up, but a vigorous revival of market demand in the second quarter of this year is expected, given that the Chinese authorities have rolled out a slew of measures to stabilize economic growth and the epidemic hopefully will taper off," said Luo Tiejun, vice chairman of the China Iron and Steel Industry Association (CISA).
Despite the optimistic outlook reported by the official English-language China Daily on Feb. 25, economic indicators point to the most challenging time for China's steelmakers in recent years.
In February, the purchasing managers' index (PMI) for the iron and steel industry, compiled by the China Federation of Logistics and Purchasing (CFLP), fell sharply to a reading of 36.6 from 47.1 a month before.
Since 50 marks the tipping point between expansion and contraction, the January reading already represented a significant slowdown.
The industry is coming off a strong year for demand in 2019, but not so much for profits.
Steel consumption rose 6 percent in 2019 to about 880 million metric tons, the official Xinhua news agency reported, citing CISA estimates.
But profits for the period were expected to decline due to weaker prices and the effects of the trade war with the United States, the Nikkei Asian Review said. That was before the additional factors of the extended Lunar New Year holiday and the coronavirus epidemic came into play.
Record inventories
Steel producers are now sitting on record inventories of products, up 45 percent from a year earlier, due to delays of infrastructure projects, factory shutdowns, logistical restrictions, and declining economic growth.
"Steelmakers usually ship these stockpiled products following the holiday season. But that has not happened this year, largely because construction companies ... have yet to resume work at many building sites," Nikkei said.
Less than half of major road and water transportation projects had restarted by the end of February, according to the Ministry of Transport, while many workers remained under quarantine.
Inventories of unsold products have filled available warehouse space, S&P Global Platts reported.
The commodity news service quoted one industry source in the southwestern municipality of Chongqing as saying that warehouses were "so full that steel had to be placed outside of the warehouses."
"He said end-user demand was recovering, but at a very slow pace, and therefore any production restarts would be modest due to the pressure of soaring steel inventories."
All the disincentives have not deterred some manufacturers in the overcapacity industry from restarting production, however.
Platts quoted one industry source as saying that "making profits is not the only reason to restart or keep running."
Other reasons include the need to secure market share, generate cash flow, and guarantee employment, he said.
The motivations of Chinese steelmakers for increasing production through good times and bad have driven an industry that makes half the world's steel, prompting tariff tensions with the United States.
Faltering auto market
China's government is also pressing the auto sector, one of the steel industry's top customers, to get back to work despite similar problems with backlogs of unsold cars.
After nearly two years of monthly declines, China's auto sales plunged 80 percent from a year earlier in February, posting the biggest decline on record, according to preliminary figures from the China Passenger Car Association, Bloomberg News said.
Production and sales both fell by more than 79 percent last month, the China Association of Automobile Manufacturers said Thursday.
Trouble has been building for years in the once-booming sector, which China has designated as a pillar industry.
"After recording growth for decades, China's auto market has been faltering since July 2018 owing to tighter emissions standards, trade tensions, increasing popularity of ride-sharing platforms and economic downturn," Zacks Investment Research said.
The government has looked to the new energy vehicle (NEV) segment to lead the industry toward growth. But NEV sales also sank for the eighth month in a row, dropping 77 percent in February from a year before, according to TechNode, a Chinese tech blog.
In January, a "vehicle inventory alert index" compiled by the China Automobile Dealers Association (CADA) rose 6.3 percent from a month earlier. The index has exceeded the "official warning level" for 25 consecutive months, said Gasgoo.com, an online provider of information about China’s auto industry.
Yet, the Ministry of Industry and Information Technology (MIIT) reported on March 4 that 84.1 percent of China's auto production bases had resumed production. Two-thirds of the workers at automotive enterprises had returned to work, Xinhua said.
The results of the rush to restart are uncertain, since assembly of cars on production lines may be stalled by missing components in some cases, while in others, completed vehicles may only add to bulging inventories.
The problems of the auto and steel industries could provide an opportunity to scale back excess production, reform China's economic model and provide a pattern for other overcapacity industries like coal, power generation and oil refining.
But Derek Scissors, an Asia economist and resident scholar at the American Enterprise Institute in Washington, sees such a policy change as an unlikely outcome.
"On paper, it's an opportunity to make fundamental changes with regard to oversupply. In practice, there's absolutely no sign of interest from the central government in this kind of reform, just as there wasn't a year ago," Scissors said.
Comfortable with overcapacity
Despite the economic crisis caused by the coronavirus epidemic, China's government has grown comfortable with the country's economic model of industrial overcapacity, overproduction and debt-disguised losses.
The only question for the government now is how soon it can restore the status quo.
"A silver lining of sorts is that Chinese industries are accustomed to sustained oversupply and financial loss," said Scissors, suggesting that a recovery from the crisis on those terms is likely.
"The first quarter is the last 15 years on steroids. China will be back to the normal levels of oversupply by the fourth quarter," he said.
Despite the strains of the epidemic, President Xi Jinping has insisted on meeting the Chinese Communist Party (CCP) goals for 2020, including the pledge to double the 2010 gross domestic product in a decade.
Sticking to the target implies major production increases by the end of the year regardless of cost.
"Efforts should be made to fully unleash the huge potential and powerful driving force of China's development and strive to achieve the goals and tasks for economic and social development this year," Xi said in a speech on the coronavirus crisis.
"There is no room for hesitancy or inaction," said a Xinhua commentary on the economic goals following Xi's address on Feb. 23.
While the government has been unambiguous about meeting the economic targets, it has been less clear about who will pay for the losses from continued overproduction.
"Ultimately, Chinese banks always take the hit," Scissors said.