TO GO WITH China-economy-environment-coal-climate,FOCUS by Tom HANCOCK In this photo taken on November 20, 2015, Chinese flags fly as a worker clearing a conveyer belt used to transport coal, near a coal mine at Datong, in China's northern Shanxi province. For decades coal has been the backbone of the northern province of Shanxi, providing livelihoods for millions of miners, while private jet owning bosses became notorious for their nouveau riche lifestyles. AFP PHOTO / GREG BAKER / AFP / GREG BAKER (Photo credit should read GREG BAKER/AFP/Getty Images)

For the past couple of decades, business professors have spun price deflation as a result of “innovative disruption”. In fact, the old economy — heavy industry — has been slowly killing itself for years. The economic slowdown in China has brought the latest example: overcapacity in steelmaking and coal mining depressing prices. Though the Chinese government understands the problem full well, its latest solution will not work.

China’s coal companies carry a lot of debt; some as much as their entire asset value. The banking regulator, China Banking Regulatory Commission, has had to get involved. To cut banks’ loan exposure to coal (and steel as well), the CBRC reportedly has plans to encourage local governments to aid the most indebted steel and coal companies by participating in debt-for-equity swaps with the banks.

Banks could use the help. In a worst-case scenario, non-performing loans could jump fivefold from the current 1.7 per cent of the total, thinks Credit Suisse. The coal and steel companies are even more needy. Shanghai-listed miners, such as Shanxi Coking Coal, jumped on the reports on Monday.

The promise of intervention in the coal and steel industries has coincided with a big rally in the prices of the underlying commodities. Thermal coal prices in China have jumped by nearly a third from the lows of late last year. Meanwhile, the proportion of Chinese steel mills losing money has dropped to a fifth; a year ago almost all were in the red. All of this eases the pressure on bloated industries and does nothing to remedy overcapacity. Steel production continued to rise in July, and exports are up more than 8 per cent this year.

Finance can provide pain relief but only harsh medicine — shutting uneconomic factories down — can offer a cure. Extending the lives of zombie coal and steel companies will only prolong the “disruption” in these markets.

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