Last year, Chinese policymakers introduced a wave of measures to try and curb overcapacity in the country’s old economy. As prices for commodities such as coal and steel collapsed, on falling demand but debt sponsored capacity expansion, policymakers decided to place limits on producers. Some of these measures are now starting to be rolled back, but further cuts are planned. Last year, Beijing’s top-down restriction on state mines’ operating days — the number that miners could work in a year — was cut from 330 to 276 and this, along with private sector closures, forced the price of coal above $100 a tonne. The National Development and Reform Commission still to cut 150 million tonnes of coal mining capacity this year, but its aims are less aggressive. In the steel industry, the national target is 50m tonnes of steel-capacity cuts this year.

old economy
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The NDRC has reportedly established an appropriate “green” trading band for the price of coal of between 500 and 570 yuan or approximately $74 to $84.4 per ton. If the price moves outside the range, the Commission will use measures to either cool or stimulate production.

Over the next month, companies across China’s Old Economy will report first half results and this will, according to analysts at Bernstein give some answers to the question analysts have been asking about China’s economy since the phrase “socialism with Chinese characteristics” was first used by the Chinese Communist Party in 1987. Specifically, this data will show the allocation of capital: corporate entities (some of whom are state-owned) with an obligation to maximize profits, or the State?

China’s Old Economy Is Staging A Surprising Rebound

In a healthy, functioning free economy, coal and steel producers seek to maximize profitability, closing plants and cutting costs when prices are low, and opening extra capacity when prices rise. It’s difficult to argue that this has been happening in China over the past few decades. When coal prices slumped, producers continued to maximize output, as they were effectively backstopped by the state through low funding costs (state owned enterprises even more so).

According to Bernstein’s analysis, since the beginning of the year, as state enforced capacity cuts have worked their way through the system, Chinese industrial metrics have been “extraordinarily strong” reflecting a “very healthy – or frankly over-stimulated – industrial economy.” During the first half cement, coal, iron ore, steel, aluminum and copper prices have all surged sending profits in the Old Economy rising. Earnings for these sectors, in both the private and state owned sectors, are projected to rise by between 42% and 45% respectively for the second quarter according to the investment bank’s analysis.

If the Old Economy can refrain from adding additional capacity (or if the state will let it), this could be the perfect opportunity to de-lever and reduce balance sheet stress that’s built up over the past decades.

Put simply; it now looks as if China is operating its industrial / Old Economy profitably and at an appropriate scale. Given the debt burden that’s built up over the last decade, a period of excess profitability will help to stabilize the industrial economy while at the same time removing stress from the financial system. The state might control the economy, but that might not be such a bad thing if it manages to avert the next crisis.