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The combination of China's strong government push, slowing GDP growth, and declining domestic demand has bolstered the risk of overinvestment for some of the country's industrial sectors.
What We're Watching
In recent years, specific sectors in China—such as power and utilities and the manufacturing of raw chemicals, electrical equipment, and autos—have experienced outsized investments in response to policy initiatives supporting energy transition and industrial upgrades.
However, as the world's second-largest economy shifts into a lower gear, subdued consumption and vigorous manufacturing investment are weighing on corporate profitability.
As a result, investment, utilization, and profitability data show that such sectors are now confronting the risk of overinvestment.
What We Think And Why
In our view, the slowdown in the world's second-biggest economy may not pass quickly, and the growth outlook for domestic markets over the next few years appears weak. The combination of soft consumption and robust manufacturing investment has led to excess capacity in several goods markets. But while overinvestment is typically an outcome of slowing economic activity weighing on domestic demand, the bigger driver in China's case is government policy.
Beijing's policy focus on manufacturing and power and utilities has been notably reflected in both the ramping up and dialing back of investments in the targeted sectors. This has resulted in fixed asset investment remaining uneven over the last decade.
Fixed asset investment in power and utilities has accelerated by approximately 20% annually since 2022, propelled by investment in renewable capacity under the government's energy transition drive. Electrical equipment (including batteries and solar panels) and technology hardware (like semiconductors) have seen elevated investment growth. In contrast, fixed asset investment in metals and mining contracted from 2015- 2017 after Chinese authorities launched policies to reduce capacity in the sector, and growth has remained tepid in the past four years.
Raw chemicals producers' profit margins have reverted to 2018 levels amid supply gluts, high costs, and a shaky demand recovery. Meanwhile, the utilization rates (defined as the ratio of actual output to production capacity) of electrical equipment makers have shrunk since the lows of the COVID-19 crisis, and their profit margins remain low compared to pre-pandemic levels. Similarly, the utilization rate in the auto industry fell 7 percentage points in 2018-2022, while profit margins continued to decline.
At the same time, the issue of overinvestment is further complicated by trade tensions that have resulted in tariffs on a number of Chinese goods (in particular, those levied by the U.S.), as well as by China's slowly changing role in global supply chains.
We expect capex and consolidation to moderate for most Chinese corporates in the next few years. However, global ambitions remain strong for some in industries facing overinvestment risks. While we believe more disciplined financial management will help most Chinese firms reduce debt, leverage will likely take years to return to pre-pandemic levels, as a slowing economy will limit profit growth.
What Could Change
Given the nature of the growth slowdown in China, we don't expect domestic demand to surprise on the upside in any significant way. And given tariff restrictions in many developed markets, this curbs opportunities for overseas expansion for many Chinese manufacturers. Still, some may find openings in emerging markets, where we forecast GDP growth to be moderately stronger this year than in 2023—albeit with significant divergence.
More importantly, as the Chinese government has been a key driver of investment activity, policy changes could prompt investments in certain sectors to contract, evidenced by the supply-side reforms in 2015. Such reforms have proven effective in reducing excess capacity in the metals and mining sector. Potential policy changes could include cutting capacity in inefficient, high-polluting manufacturing. It could also include deleveraging, controlling spending, and improving resource allocation to enhance efficiency.
Meanwhile, trade with the so-called Global South may emerge as a mitigating factor to overinvestment risks. While China's goods exports to developed markets have slowed, the country's share in global exports has held up, thanks to more trade with emerging markets.
Over the long term, the bigger challenge is that with fewer market forces at play, large government-led investments may more easily veer into excess —like a ship that takes too long to turn around. As strategic considerations drive more countries to pursue such programs, more of them may find themselves facing overinvestment risks.
Writers: Joe Maguire and Molly Mintz
This report does not constitute a rating action.
| Primary Credit Analyst: | Charles Chang, Hong Kong (852) 2533-3543; charles.chang@spglobal.com |
| Secondary Contact: | Alexandra Dimitrijevic, London + 44 20 7176 3128; alexandra.dimitrijevic@spglobal.com |
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