China's Robust Economic Growth to Face Pressure in 2018

By FeaturesDow Jones Newswires

HANDAN, China -- Steel makers all over this soot-covered city offer a glimpse into why China's hard-charging economy is expected to come under pressure this year.

Growth in the world's second-largest economy accelerated for the first time in seven years last year, reaching 6.9% on rising demand from both home and abroad, official data released Thursday show. That faster-than-expected pace bolstered factory prices and left steel makers like the Xinjin Group awash in profits.

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Even so, Xinjin and other manufacturers aren't expanding. "We're not adding any new capacity," says Wang Zhiqiang, a production manager at the privately-held steel company in the northern city of Handan.

The uptick in growth in 2017 bucked a long downdrift from a peak in 2010, and led some economists and investment banks to herald a "new cycle" of growth for the economy.

Beyond the headline performance, the outlook appears hazier to many economists. Key drivers of last year's expansion, from investment to consumption, appear to be weakening, undermined in part by a government effort to wring out excess manufacturing capacity and purge risky lending from the financial system.

"Optimism about China's economic growth in 2018 is not warranted," says Yu Yongding, a prominent Chinese economist and a former adviser to the central bank.

While growth in the final quarter of 2017 reached 6.8% year-on-year and matched that in the previous quarter, a slew of indicators released by the government show fading momentum going into 2018. Chief among them is investment in buildings, factories and other fixed assets -- a traditional fuel for expansion -- which rose 7.2% last year, its lowest pace in more than a decade.

In Handan, a city of nine million encircled by dozens of steel mills, cement plants and coal pits, most companies aren't expanding production despite record profits, according to Song Jijun, an adviser to the local government. Instead, he said, the companies are either sitting on their profits or investing in environmental improvements.

The government's campaign to rein in risks and unneeded industrial capacity intensified last year. But its effects were more than offset by a pickup in trade boosted by a global recovery and by infrastructure projects and a surging property market that benefited a wide swath of industries, from steel to cement and furniture.

Now the campaign is beginning to bite harder, testing its resolve should growth dip below 6.5% -- thought to be the government's bottom-line target.

Chinese exporters face rising prospects for trade conflicts with major trading partners, especially the U.S. About 9% of last year's economic expansion came from net exports, the highest such reading in a decade and a turnaround from the previous two years when trade had been a drag on the economy.

Meanwhile, the government's continuing efforts to prevent property speculation are hitting home prices in megacities such as Beijing and Shenzhen. Household consumption is also expected to slow as high property prices and increased borrowing leave consumers more strapped.

China's banking regulator, in an interview with the authoritative state-owned People's Daily newspaper this week, cited household debt as a prominent concern. Retail sales grew 10.2% last year, a slower pace from the year earlier.

That leaves investment, which is falling as Beijing sustains its clampdown on financial risks. In recent months, the central government has canceled some subway and other infrastructure projects around the country to control rampant borrowing by local governments.

At a briefing this week, Shen Ying, chief accounting officer at the government commission that oversees major state-owned enterprises, said big state firms with high levels of debt are barred from making new investments. That's despite the fact that state companies controlled by the central government saw their profits jump 15.2% last year -- the highest growth rate in five years -- to reach about $219 billion.

Many manufacturers, like steel makers and coal miners, in the past year have benefited from government policies aimed at reducing excess capacity. That drive forced many small and heavy-polluting producers out of business. Coupled with a rebound in demand driven by roaring home sales, the reduction in suppliers led to a surge in prices for factory goods, bolstering corporate coffers but decreasing incentives to expand.

"If a company has monopoly, why would it want to ramp up capacity?" says Zhong Zhengsheng, director of macroeconomic analysis at CEBM Group. "It already makes so much money."

Profit growth last year was concentrated in eight industrial sectors, including coal, steel and aluminum, according to an analysis by Xu Qiyuan, a senior economist at the Chinese Academy of Social Sciences. Other industries including textiles and food-processing actually saw profits decline.

Mr. Xu notes that some companies increased capital spending last year to upgrade their facilities, but said they have shown few signs of increasing investments this year.

That's the predicament Xinjin, the steel maker in Handan, is in. Owned by a local steel boss and with more than 5,000 employees, Xinjin survived the government's capacity-reduction drive by upgrading its facilities and product mix.

Its fortunes shifted last year, when the forced closing of many of its peers helped lift demand for its products, mostly steel sheets used in making home appliances and auto parts. Xinjin's net profits jumped 90% to more than $312 million, a record for the company.

In a normal market, the company would increase investment, taking advantage of its soaring profits, Xinjin executives said, but that's not an option under current government restrictions. On a recent visit to its facilities, some production lines were running at half capacity, while many workers were planting trees dotting the roads inside its giant industrial campus.

"Government policies are very effective," says Mr. Wang, the production manager. "They helped grow our profits and now they're making it impossible for us to expand."

--Liyan Qi contributed to this article.

Write to Lingling Wei at lingling.wei@wsj.com

(END) Dow Jones Newswires

January 18, 2018 09:36 ET (14:36 GMT)

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