China faces to lose its biggest industry to rising debt

The world’s biggest steel industry in China is in grave crisis.

A combination of factors including a slowing Chinese economy, the second biggest in the world, as per a CNN report, falling commodity prices and an industry drowning in debt has resulted in this disaster, reports Business Insider according to Yahoo News.

State-owned enterprise (SOE) Sinosteel defaulted on a debt-interest payment of $315 million on bond notes maturing in 2017, earlier this month.

This is a blaring sign, that despite the country’s efforts at fiscal-policy easing and its pledges to reform "zombie" SOEs, the worst may be coming faster than policymakers expected, reports Business Insider according to Yahoo News.

The pride of old China

Asia’s largest economy, China is to make the difficult transition from one based on investment to one based on domestic consumption.

Hence it is useful to think of China’s economy in two parts: new China and old China.

New China includes businesses in the services sector, like technology, retail, and banking.

Old China includes the country's once booming property and construction sectors, manufacturing, and Chinese exports.

It is important to note that old China—which includes a bunch of SOEs—is carrying a ton of debt resulting in companies to become less profitable as they spend a good portion of money making payments on that debt, reports Business Insider according to Yahoo News.

As new China rises, old China is slowly but surely fading.

However the rise in new China is happening slowly, but the old China is fading faster than anyone thought.

The Chinese government faces the colossal challenge of managing this transition without a string of credit events crippling the economy.

That's where the danger in China's steel industry comes in.

Asking for help

As Bloomberg reports, Zhu Jimin, the deputy head of the China Iron & Steel Association (CISA), said on Wednesday that collapsing demand is putting the entire industry at risk.

From Bloomberg:

“Production cuts are slower than the contraction in demand, therefore oversupply is worsening,” said Zhu at a quarterly briefing in Beijing by the main producers’ group. “Although China has cut interest rates many times recently, steel mills said their funding costs have actually gone up.”

“China’s steel demand evaporated at unprecedented speed as the nation’s economic growth slowed,” Zhu said. “As demand quickly contracted, steel mills are lowering prices in competition to get contracts.”

Average steel prices hit an all-time low on July 9. CISA notes that in September, steel demand contracted 8.9% from the same time a year before, and medium and large steel mills have lost $4.4 billion in the first nine months of 2015.

The restructure

That means China may need to both clarify and speed up its five-year plan to reform state-owned organizations.

Sinosteel's default indicates that it, and other SOEs carrying a ton of debt, may not be able to wait years for debt restructuring.

"I don't know how the government can push ahead with the SOE reform, it will be extremely difficult," one senior executive with China's top aluminum producer, Chinalco, told Reuters.

Winter is coming. That means construction will slow and demand for steel will weaken more.

And when that happens, China will have to make a choice. Prop up its steel industry or make the rare decision to let companies collapse under the weight of their debt.