Raw materials crises endanger China's expansion

By James Kynge, Financial Times
Published: April 12 2004 5:00 | Last Updated: April 12 2004 5:00 

Down on his luck and unable to get a job, a migrant worker in the scenic Chinese city of Guilin recently turned to a novel source of income. He stole iron manhole covers from the city's roads, hammered them into unrecognisable forms and sold them as scrap.

His moonlight endeavours, the Guilin Daily observed, were rewarded by China's high prices for scrap steel. But they wrought terrible consequences on unsuspecting motorists as their wheels plunged into the holes.

Frenzied economic activity sooner or later hits physical constraints. Economic officials said that although gross domestic product growth in the first quarter of this year was expected to outpace last year's 9.1 per cent, physical limitations threatened the sustainability of such an expansion.

"Shortages of grain, water, electricity, coal, transport capacity and other things are becoming clearer and clearer," said one official in a key economic ministry. "We have to cool things off or prices may start to rise even more sharply."

Preliminary figures for the first quarter of this year show that industrial output climbed 17.7 per cent, higher than the 17.2 per cent increase in the first quarter of 2003. The strength continued to come from those industries, such as steel and cement, that are feeding an investment bonanza.

Steel output rose nearly 30 per cent over the same period last year, and cement climbed 24 per cent. Production of some key consumer items, such as cars, mobile phones and notebook computers posted growth of 40 to 65 per cent.

The robust performance has intensified Beijing's concerns. Wen Jiabao, the premier, warned last month that the task of maintaining a sustainable rate of growth this year would be tougher than last year's efforts to tame the Sars (severe acute respiratory syndrome) epidemic. In particular, he warned of the need to avoid cycles of boom and bust.

Inflation is the key barometer. Many Chinese economists say that if the consumer price index rises for some months beyond the bank lending rates of between 5 and 6 per cent, then Beijing may be forced to raise interest rates and risk an abrupt slowdown in economic activity.

Although the consumer price index in February showed a moderate 2.1 per cent rise, down from 3.2 per cent in January, some analysts expected a significant year-on-year increase in March driven partly by a surge in unprocessed grain prices during the month.

China's grain problem, often explained away as the product of poor weather, is in fact long-term and structural. Reserves are falling after several years of declining harvests, agricultural land is being absorbed by urbanisation and farmers are turning to other crops, such as fruit and vegetables.

But in the long run, water shortages are the main issue. "China faces a serious problem of water shortages. This has become one of the important factors restraining economic development this year," said Wang Jirong, a senior official at the State Environmental Protection Administration.

China is short of 30bn to 40bn cubic metres of water a year, equivalent to the capacity of the 175 metre deep Three Gorges reservoir.

The other key physical constraint on growth is power. In the first quarter of the year electricity production increased by about 15 per cent, yet 24 provinces experienced blackouts or power rationing, up from 21 last year.

Song Mi, deputy chairman of the State Electricity Regulatory Commission, said the country faced a shortfall of 20m kilowatts this year, twice last year's deficit. The shortage will be most acute in booming eastern and southern China and, as summer approaches, consumer demand is expected to rocket.

The effect of this is two-fold. First, it will increase pressure on the government to raise the price of power, thereby giving inflation another boost. Second, it may build on a process that Beijing welcomes: the weeding out of inefficient industrial capacity. In the aluminium industry, for example, 400,000 tonnes of capacity was shut down in the first two months of the year because of the rising prices of power and raw materials. In the steel industry too, a power price increase last year is hurting less efficient producers.

Li Qixiang, vice-chairman of Nanchang Iron and Steel Company, said his company had mothballed a planned 1m tonne expansion because the price of inputs was rising. The prices of some other metal products have started to ease.

But it is unclear whether this will significantly reduce the appetite for capacity expansion among makers of steel, aluminium, copper and other products. Beijing is hoping that it will, and the central bank is applying increased pressure to rein in lending to such sectors.
 

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