The State-Business Nexus in China’s Steel Industry - Chinese Market Distortions in Domestic and International Perspective Presentation of the Report prepared by THINK!DESK China Research & Consulting for EUROFER – the European Confederation of Iron and Steel Industries February 2009

For the last 20 years, China’s crude steel output has grown exponentially from about 50 million tons (mid 80s) to nearly 500 million tons in 2007. Especially in the new century, China’s steel production expanded dramatically with production in 2007 having increased by 250% in only four years. 1. The Chinese Steel Miracle The State-Business Nexus in China’s Steel Industry Development of the Chinese steel industry, 1949 - 2007

For the last 20 years, China’s crude steel output has grown exponentially from about 50 million tons (mid 80s) to nearly 500 million tons in 2007.

Especially in the new century, China’s steel production expanded dramatically with production in 2007 having increased by 250% in only four years.

Today, China has become the – by far – largest steel nation in the world. In terms of crude steel production, China presently commands a share of more than one third of the world’s total output (36% in 2007) 2. Conquering the Global Markets The State-Business Nexus in China’s Steel Industry Since 2006, China has become the – by far – largest steel exporter in the world. In 2007, Chinese steel exports already held a share of 21 percent of all internationally traded steel.

3. Market and State in the Chinese Steel Industry The State-Business Nexus in China’s Steel Industry China’s steel industry is integrated in a multi-layered system of politico-business alliances: The ‘China Steel Inc.’ is bringing together central government’s top policy makers and top managers of the leading steel conglomerates. Substituting the traditional system of top-down planning the ‘China Steel Inc.’ has become a new, highly effective cartel determining long-term industry planning and providing corporate leadership to the Chinese steel industry

China’s steel industry is integrated in a multi-layered system of politico-business alliances:

The ‘China Steel Inc.’ is bringing together central government’s top policy makers and top managers of the leading steel conglomerates.

Substituting the traditional system of top-down planning the ‘China Steel Inc.’ has become a new, highly effective cartel determining long-term industry planning and providing corporate leadership to the Chinese steel industry

4. Market Failure Meets Policy Failure The State-Business Nexus in China’s Steel Industry However, the ‘China Steel Inc.’ is not almighty, but facing a group of local ‘renegade’ state-business alliances defying central policies as well as unwelcome initiatives of other local alliances. Market failure meets policy failure! The ‘toxicity’ of Chinese government interventions in the market process is further enhanced: - overcapacities remain in place - market clearing processes are not allowed to unfold - price distortions are exaggerated by discretionary allocations Spillovers of Chinese domestic market distortions on the global markets are becoming increasingly ‘toxic’

5. Governmental Micro-Management – Some Instruments The State-Business Nexus in China’s Steel Industry Grants, equity infusions, unpaid dividends and other preferential access to capital Government infusions (18 bn RMB Ma’anshan) Debt-equity swap (27.5 bn RMB Anshan, Baosteel, Lanzhou, Shougang, Taiyuan) Government foregoing dividend payment (industry profit around 190 bn RMB in 2007) ‘ In-kind’ contribution: Government provides productive assets to another company through govenment-mandated mergers (51% stake in 3 MT E’cheng to Wuhan at no cost) Access to policy-driven lending at favourable rates 47 companies benefited from preferential lending through State Key Technology Renovation Project Fund including Anshan, Baosteel and Panzhihua (75 bn RMB) Low cost loans for major listed steel companies such as Baosteel, Wuhan, Anshan and Shougang China Development Bank committed to provide Anshan with 18 bn RMB loan including 10 bn at preferential rates , to promote strategic development of the company Preferential tax programmes Tax refunds, tax breaks and tax cuts foregoing tax collection worth 7.6 bn RMB from listed steelmakers (Transparency on central government programmes only, not on local level) Preferential access to inputs, land and energy Free use of land or at less than adequate remuneration (Baosteel, Anshang, Xinyu) State-owned steel companies provide steel substrate (HR) to rerollers at significantly depressed price levels

6. There Are No Cost Advantages The State-Business Nexus in China’s Steel industry China does not have a genuine competitive cost advantage justifying its increasingly dominating presence in the international markets, notably the EU. Moreover, netting out subsidies and impact of government market interventions would proof the real «market-based» cost structure of Chinese steel production to be substantially higher than nominally reported. Chinese cost calculation incorporating subsidies, see analysis «Does the Chinese Steel Industry Posses a Genuine Competitive Cost Advantage», Full Report, page 35

China does not have a genuine competitive cost advantage justifying its increasingly dominating presence in the international markets, notably the EU.

Moreover, netting out subsidies and impact of government market interventions would proof the real «market-based» cost structure of Chinese steel production to be substantially higher than nominally reported.

7. Discretionary Interventions at the Global Markets Interface The State-Business Nexus in China’s Steel industry VAT export rebates, export taxes, export/import licensing, quota systems, etc. Capacity for discretionary fine tuning of cost-based export incentives and disincentives on the product level. High flexibility with only days separating policy decision from implementation.

VAT export rebates, export taxes, export/import licensing, quota systems, etc.

Capacity for discretionary fine tuning of cost-based export incentives and disincentives on the product level.

High flexibility with only days separating policy decision from implementation.

The State-Business Nexus in China’s Steel industry The Chinese steel industry is firmly embedded in a powerful state-business nexus. Chinese governments support ‘their’ steel enterprises by a broad array of mechanisms which are not conforming to the principles of competition based markets. China does not possess a genuine competitive cost advantage in steel making. The Chinese steel industry’s export offensive is not based on superior competitiveness, but rather its access to resources at below market prices. Chinese government organizations are interfering in the global market system, impeding its allocative and welfare enhancing function. Given the absolute size of the Chinese steel sector, fluctuations in its supply and demand patterns do have a substantial potential for destabilizing the global steel and their raw materials markets. Given the phenomenon of a twin market failure plus policy failure in China’s steel markets the China factor has become a risk to global steel market development. 8. In a Nutshell

Prof. Dr. Markus Taube Partner THINK!DESK China Research & Consulting GERMANY Phone: +49 - (0)176 - 21 603 441 Internet: www.thinkdesk.de E-Mail: [email_address] Skype: thinkdesk Twitter: www.twitter.com/thinkdesk Slideshare: www.slideshare.net/thinkdesk XING: http://www.xing.com/net/china/ DISCLAIMER: The information contained in this presentation is based upon or derived from sources that are believed to be reliable; however, no representation is made that such information is accurate or complete in all material respects, and reliance upon such information as the basis for taking any actions is neither authorized nor warranted. This presentation is intended for the use and assistance of clients of THINK!DESK China Research & Consulting. It should not be regarded as a substitute for the exercise by the recipient of their own judgement. THINK!DESK China Research & Consulting and/or any person connected with it accepts no liability whatsoever for any direct or consequential loss of any kind arising out of the use of this presentation or any part of its contents. It should be noted that a variety of factors, including e.g. changes in prices, shifts in demand, variations in supply, international currency movements, technological developments, governmental actions and/or other factors, including our own misjudgements or mistakes, may cause the statements herein concerning present and future conditions, results and trends to be inaccurate. Contact