India and the problems with Chinese manufacturing overcapacity

Manufacturing overcapacity is a cause of concern for any economy. However, it has wider global ramifications. For instance, the US steel industry also went through this phase. In the 1970s and 1980s, the US steel industry experienced significant overcapacity. Despite declining demand for steel in the United States due to various economic and technological changes, steel manufacturers continued to produce at high levels. This overproduction led to a glut of steel in the market, causing prices to plummet and profits to erode. The industry’s overcapacity resulted in severe consequences, including widespread plant closures, job losses, and a long period of economic hardship for communities reliant on steel production. The situation was exacerbated by the industry’s slow response to global competition and technological innovation, which made it difficult to adjust to the changing market conditions.

Relating this to the current situation of manufacturing overcapacity in China, we see parallels in the potential for economic disruption. Like the US steel industry, China’s aggressive expansion in manufacturing capacities, particularly in green goods like EVs and solar panels, is creating a surplus that exceeds both domestic and global demand. This overcapacity risks leading to similar outcomes as those experienced by the US steel industry, including price pressures, reduced profitability for manufacturers, and potential trade tensions as other countries respond to the influx of cheap Chinese products. The situation is compounded by subsidies and state support, which can distort market signals and lead to inefficient allocation of resources.

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But why is this happening now? The answer is simple. Chinese lending is shifting from the property sector to manufacturing, leading to concerns about overcapacity. Within a span of less than four years, Chinese banks have transitioned from granting over one trillion dollars in new loans annually to the property sector to observing a net reduction in outstanding debt for the first time since records began in 2005. In contrast, the third quarter of 2023 saw these banks extend nearly $700 billion in new loans to the manufacturing sector, often at interest rates below market levels. This surge in lending has facilitated the rapid expansion of new manufacturing facilities across China, specializing in products like electric vehicles (EVs) and batteries.

However, with domestic consumption not being able to fully absorb this increased production, there are reports of China dumping this overcapacity in the international markets. In the lithium-ion battery cell industry, for example, the expansion has surpassed demand, leading to predictions of industry consolidation. The utilisation rates of gigafactories, which are crucial for battery production, were at 45 per cent in 2022 and have further declined in the first half of 2023, highlighting the extent of the overcapacity problem.

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The oversupply has led to drastic price reductions in key components, such as lithium carbonate, a critical material for rechargeable batteries. Prices have plummeted more than 80 per cent from their peak, which has had a significant impact on the profitability and sustainability of companies within the sector.

It’s becoming increasingly evident that this maneuver may not be merely an economic realignment but could also be construed as a calculated move by China to unsettle global market dynamics. This development demands a closer examination, as its repercussions extend beyond national borders, challenging the equilibrium of international trade and industry competition.

In fact, the US has recently warned Beijing against dumping goods on global markets as it fears China would be easing domestic overcapacity with cheap exports.

However, addressing overcapacity has become a persistent challenge within Chinese industrial strategies. This issue, akin to a resilient virus, proves tough to eradicate and necessitates ongoing efforts to manage. Typically, this involves state-led consolidation of industries, which results in the elimination of less competitive firms. The survivors, having weathered the storm, emerge stronger and more aggressive, particularly in international markets, thereby intensifying the original problem. BYD is greatest example. It has become world’s largest EV company, overtaking Tesla.

The impact of this overcapacity is multifaceted. In Europe, the influx of cost-competitive Chinese EVs, for example, is threatening the continent’s nascent EV production, prompting the European Commission to launch anti-subsidy investigations into imports of Chinese-made passenger battery electric vehicles. Similar concerns are arising in other green technology sectors, with potential for further trade disputes and investigations into China’s dominance in clean energy supply chains, including wind turbines and heat pumps.

Moreover, the situation in China’s manufacturing sector is characterised by heightened volatility, with industries like steel and automobiles experiencing significant fluctuations in demand and profit margins. This volatility, exacerbated by the uncertain global economic environment since 2008, makes planning difficult for China’s manufacturers, who are facing challenges from rising labor costs and the need to achieve manufacturing excellence amidst slowing growth.

For global manufacturers, this presents a complex problem. On one hand, the overcapacity in China might lead to lower prices for green goods, potentially accelerating the global transition to cleaner energy. On the other hand, it could undermine manufacturing in other countries, leading to trade tensions and necessitating strategic shifts in global supply chains and manufacturing strategies to remain competitive.

As far as India is concerned, the Standing Committee on Commerce has made several key observations regarding the impact of Chinese goods on various sectors of the Indian industry. For instance, the solar industry, which is crucial for India’s renewable energy goals, relies heavily on imports from China, accounting for 84 per cent of the solar requirement of the National Solar Mission. The significantly lower import prices of these commodities in India compared to other countries like Japan and Europe suggest that Chinese goods might be dumped in the Indian market.

India, through PLI, is already incentivising domestic manufacturing of some of these goods, such as high-efficiency solar modules. It is crucial to focus on nurturing the domestic solar manufacturing ecosystem, countering the overwhelming dominance of Chinese solar products in the market. With China’s significant market share in global solar manufacturing bolstered by substantial government support and predatory pricing, India’s reliance on imports has stifled local production and exposed the country to supply chain risks. There is a need to close free trade agreement loopholes, especially the ones in the ASEAN FTA. Solar products are one such example. Such efforts will have to be undertaken in other areas, too. Regular investigations by countries to check whether China dumped a range of goods now become very important.

The author(X: @adityasinha004) is OSD, Research, Economic Advisory Council to the Prime Minister. Views expressed in the above piece are personal and solely that of the author. They do not necessarily reflect Firstpost’s views.

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