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China's excess production a threat

`Since 1997, China has been buffeted by constant overproduction and deflationary pressures. If the Chinese government wants to solve these problems, it has to increase industrial competitiveness and production efficiency, which is also the goal of its 11th five-year plan.'

People have become accustomed to calling China the "factory to the world" as a way of describing its unchallenged position on many world markets for manufactured goods. However, China may also become the "warehouse to the world," as serious excess production capacity in many industries has led to huge inventories. Large amounts of capital are tied down in these inventories, which is leading to deflationary pressures around the world.

This year, Beijing is trying to prevent a crisis precipitated by this excess production capacity. It is studying a plan to cut credit to 11 industries, including the steel, automotive, electric, coal and textile industries. However, deflation is a much more serious problem than the Chinese government realizes.

Over the past few years, people have often said that China's economy is overheating and that macroeconomic measures are necessary to cool it down. Commodity prices have been rising, mainly as a result of increasing food prices, and the prices of staple foods in particular. In September 2003, food prices increased by 3.2 percent from the previous month. They kept going up, and in July 2004, they increased by a whopping 14.6 percent.

Beginning in August 2004, however, bumper harvests caused the rate of price increases to slow. In January last year the rate of increase was down to 4 percent, and by June it had dropped to 2.1 percent.

On the other hand, although the prices of non-foodstuffs increased slightly, that increase had been slow. From the middle of 2004 until today, prices of non-foodstuffs rose by less than 1.3 percent. All in all, from September 2003 to last October, the correlation between changes in commodity prices and food prices was 98 percent.

It seems that China's inflation problem is becoming irrelevant. The fact is that China hasn't managed to leave its pre-2002 deflation problem behind. According to a survey conducted by the national commercial information center of market supply and demand conditions for 600 products, 78 products -- or 12.8 percent of the total -- saw balanced supply and demand in the first half of 2001.

Supply exceeded demand for 527 products, or 86.5 percent of the total. Demand exceeded supply for only four products, or 0.7 percent of the total.

Although the number of products for which supply and demand are in balance has increased since then, there are no longer any products for which supply falls short of demand.

During the second half of 2002, supply exceeded demand for 88 percent of all products, while 12 percent of products were in balance. By the second half of last year, supply exceeded demand for 71.3 percent of all products, while supply and demand for the remaining 28.7 percent were balanced.

All this shows that although deflationary pressures have fallen slightly, they are still serious.

Serious deflationary pressures lead to increasing corporate inventory, losses and even serious financial risk. In the first half of last year, the value of finished product inventories in China's industrial corporations reached 1,154.9 billion yuan (US$143.5 billion), an increase of 19.5 percent. Furthermore, between January and October, lossmaking industrial corporations at the national level lost 172.5 billion yuan, or 62.6 percent more than the same period in the year before.

More seriously, state-owned and state-controlled lossmaking enterprises lost 92.8 billion yuan, an increase of 102.4 percent. At present, Chinese investment in fixed assets remains fairly rapid, and it is directed by local governments. The ratio of national government investment in government plans to local government investment in local projects is 1:8.4. This situation easily leads to blind investments and overlapping projects.

Following a cooling down of the economy, it is all too possible that such construction investments will turn into bad loans, further aggravating an already serious financial crisis.

Since 1997, China has been buffeted by constant overproduction and deflationary pressures. If the Chinese government wants to solve these problems, it has to increase industrial competitiveness and production efficiency, which is also the goal of its 11th five-year plan.

Until this problem is resolved, however, China-based Taiwanese businesspeople must be cautious in their investments, in order to avoid being drawn into a cutthroat battle resulting from excess production capacity. Close attention must also be paid to the bad loans and the financial crisis that may result from China's excess production capacity.

Tung Chen-yuan is an assistant professor in the Sun Yat-sen Graduate Institute of Social Sciences and Humanities at National Chengchi University.

Translated by Perry Svensson
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