China's overcapacity will get worse, warns CLSA

Capacity utilisation predicted to deteriorate to 73%.

Beijing's attempts to grow the economy too fast has brought about China's two biggest problems - overcapacity and local government debt. According to Francis Cheung, Head of China-HK Strategy at CLSA, capacity utilisation is back to the 2008 GFC level of about 78%, which creates deflationary pressure, and is below the optimal range of 80-88%.

"China has a history of overcapacity but the problem has grown so large that it requires not just strong demand to absorb it, but solid global demand. Part of the cause was wishful thinking that old capacity would be closed, but part of it was due to industrial subsidies that contributed at least 30% to net income," adds Cheung.

Unfortunately, the worst is yet to come. Speaking at the CLSA Investors Forum 2013, Cheung warns that overcapacity will worsen unless Beijing takes decisive action such as closing down large excess capacity. But this seems to be a long way off as the government's new plan to overcome excess capacity only proves to be a lot like the old plan that failed.

"By 2015, we expect capacity utilisation to deteriorate to 73%, closer to the critical level of 70%. This will increase deflationary pressures and risk of bad debts."