Ryan Woo, Min Zhang

BEIJING, (Reuters) – Debt issues at a Chinese property developer have spilled into a critical artery of China’s industrial engine – steel sector – which has started to spread to other crucial parts of the second-largest country in the world.

As a result, policymakers need to be cautious about the increasing balance sheet crisis at real-estate firms. An increase in steel’s fortunes would have severe repercussions for China, where cement, glass and other household goods are also vulnerable.

Steel prices already are lower than their previous record highs due to less demand from construction, which accounts for more than half of all steel’s use. However, the steelmakers’ shares prices have been hit.

Steel’s high sensitivity to changes in manufacturing and construction makes it an important indicator of China’s economic health. The slowdown has begun to show signs since the second quarter. Steel companies are large employers and support vast supply chains.

To save money in an industry that is struggling to find cash, developers of real estate have cut back on investment in steel operations.

We normally store steel products in winter at lower prices, and then sell them when the consumption returns after the holidays. We are holding back this year,” stated Qi Xiaoliang (a Beijing-based steel trader).

He stated that “there’s still uncertainty about the real estate markets for 2022, and it is unlikely to change for the next six to twelve month.”

The property market suffered a more severe blow in the last quarter of 2021. Unease within the sector caused already low buyer sentiment to shake. In November, unsold stock in China’s 100 largest cities reached a 5-year high.

The demand for housing is predicted to rise further by 2022. It will also affect downstream household product manufacturers.

Another construction material was cement production. It was around 16% lower than in September-November 2017. In recent months, there has been a drop in demand for earth-excavers.

Another example of the broadening impact that property slump had on other industries was seen. The appliances industry is an example. Monthly refrigerator production has dropped from May through November, on an annually basis.

REVERSAL IN FORTUNES

The steel producers performed amongst the most well of China’s entire economy in the first quarter of 2021. China’s major listed mills earned over 106 Billion Yuan ($16.61B) in net profit, an increase of 174% year on year and 129% more than pre-pandemic 2019.

However, the boom years in the steel industry are over. China’s huge construction industry has been paralysed, and this is leading to a very rare decline in countrywide building activity.

Floor area has contracted in new construction since July, a long stretch of declining since 2015.

China has seen a slowdown in its real estate industry, which has impacted China’s crude steel production by over 20% each month since September.

It is the closely monitored steel equity instruments that have witnessed the most dramatic reversal in fortunes, as has commodities futures.

The CSI Steel Equities Index has lost roughly 90% since mid-September. Meanwhile, futures prices of construction materials rebar, wire rod, and steel have fallen by 24%, 31%, and almost all their gains in this year’s 2018 to their historic highs.

The key ingredients used in steelmaking are also under pressure. Dalian Commodity Exchange ironore futures fell more than 45% compared to their May record.

From the late September peak, gross profit for steel bars has started to decline.

UNCERTAIN OUTLOOK

China’s largest contributor is China’s property-related sector, which accounts for 28% GDP in 2021. This figure has fallen from 35% in 2016, when it was at its highest point.

According to Moody’s (NYSE): The GDP share can be broken down as a direct contribution of property at 7% and an indirect contribution of construction at 21%.

An industry consultant for government projects that China’s demand for steel will fall by 0.7% in 2022 after a predicted 4.7% decrease this year.[nL1N2T102U]

Fitch Solutions’ analysts recently wrote to clients that an increase in credit limits could “reduce demand for metals used for construction” as developers become less able to purchase raw materials at higher prices.

The producers of white goods and appliances, which are a critical part of China’s manufacturing base, will be affected if the current contraction in construction spending continues.

Frederic Neumann from HSBC, co-head of Asian Economics Research said that “property construction has been the heart of China’s economy for more than two decades.”

With building activity expected to stay low for quite some while, growth will undoubtedly slow down.

($1 = 6.3813 renminbi)