Cutting excess capacity poses challenges to China's economy: UBS

Ongoing excess capacity reduction in China will result in job losses, less consumption, slower growth and higher debt, UBS Securities said in a report.

The lengthy report, titled "The Economic and Financial Impacts of Excess Capacity Reduction," identified coal mining and iron & steel as the main excess capacity sectors, while cement, flat glass, aluminum smelting and ship building are also included.

The Chinese government made reducing excess capacity a top priority in late 2015 at the Central Economic Work Conference and put it at the center of the 13th Five-Year-Plan.

China plans to cut steel and coal capacities by about 10 percent -- as much as 150 million tonnes of steel and half a billion tonnes of coal --in the next few years with funds set aside to help displaced workers.

"We estimate that a 10-percent capacity reduction in six excess capacity industries may lead to job losses of 3 to 3.5 million people, a 0.2-percentage-point decline in consumption growth, and less than 0.5-percentage-point drop in GDP growth," said the report.

Overall, the effect on growth and employment will be manageable, but concentrated in a few provinces such as Hebei, Inner Mongolia, Jiangsu, Shaanxi and Shanxi. The concentrated nature of excess capacity means closures may be devastating for local economies, which will require central government support.

North China's Shanxi Province with 25 percent of China's coal capacity, plans to reduce coal production by 100 million tons and suspend approval of new mining projects by 2020. Neighboring Hebei Province, producer of 23 percent of China's steel, aims to cut steel capacity by 100 million tons by 2020.

However, the actual pace will depend on central and local government determination and financial support, UBS said.

The report estimated total liability of the six sectors at 10 trillion yuan (c.1.5 trillion U.S. dollars) in 2015. Endi