BEIJING (BLOOMBERG) - In pockets of China's industrial heartland, a government push to clean up the environment and cut excess output is starting to bite: Furnaces have gone cold, the lights have been switched off, migrant workers are drifting back home.
Mr Liu Xiaoping, a resident of the sprawling, smoggy, steel-making hub of Jinan in the northeast is among the campaign's collateral damage. Standing in a cul-de-sac where most factories were closed on a recent weekday visit, he says officials ignored his pleas for more time to comply with regulations at his 20-year-old plastic mould business. As officials threatened to cut off electricity, Mr Liu shut down his factory before they could do so.
"It was like a knife falling," Mr Liu said, claiming that the chop in mid-September left him with one million yuan (S$205,473) of idle equipment and 10 unemployed staff in a city where more than 7,000 businesses labelled "messy and polluting" have been targeted for clean-up or closure.
"None of us know what to do," he said.
While it may be little consolation to Mr Liu, the impact from efforts to cut capacity is proving double edged - factory profits have surged and reflation has taken root across industry, giving a much needed boost to indebted companies. Third-quarter gross domestic product numbers due on Thursday (Oct 19) are likely to show the world's second-biggest economy remains in a sweet-spot, with a 6.8 per cent pace of growth expected, according to a Bloomberg survey of economists.
Still, the drag may intensify. Economists estimate the expansion will slow to 6.4 per cent next year and 6.1 per cent in 2019.
For China's leadership - gathering this week at the 19th Communist Party Congress - cleaning the noxious skies and filthy rivers has become a priority.
In contrast to previous leaders' growth-at-all-costs approach, President Xi Jinping and his premier have declared war on pollution, spurred by the anger of citizens enshrouded in smog that's sometimes more than 50 times more toxic than levels deemed safe by the World Health Organisation.
That political will overlaps with an economic need to rein in surplus production of steel, aluminium and other basic materials after years of over-investment. How and when that capacity gets replaced will be a key factor in the economy's performance beyond 2017.
"The last time we saw this kind of effort to cut capacity was at the end of the last century, when premier Zhu Rongji was determined to shut down money-losing state enterprises," said vice-chairman Tao Dong for Greater China at Credit Suisse Private Banking in Hong Kong. "There'll be short-term consequences for growth and jobs but it's hard to quantify at this moment, all depending on whether the capacity will remain shut after the Party Congress."
People's Bank of China Governor Zhou Xiaochuan said in a statement following meetings of the International Monetary Fund in Washington last week that the economy may keep its momentum from the first half of the year.
Capacity shutdowns are rippling across the nation with officials estimating hundreds of thousands of small enterprises may be closed. State enterprises are not being spared the knife either, though policy makers are cushioning the impact of those cuts.
Jinan Steel, a unit of Shandong Iron and Steel with about 20,000 employees, was among those shuttered in July, the furnaces falling cold. Many workers, though, were relocated to a group plant at the coastal town of Rizhao, about four hours' drive away.
Premier Li Keqiang visited the company in April and told workers that while the closure would take a toll, the nation would work to ensure employees are shifted to new positions rather than laid off.
Stock filings show that the company planned lower production of crude iron and steel this year than last. Calls to the company for comment went unanswered and it did not immediately respond to e-mailed questions.
In Zouping county, about a two-hour drive from Jinan, privately-owned China Hongqiao Group, the nation's biggest aluminium smelter, said in August that it would cut annual production capacity by 2.68 million metric tons, or about 29 per cent of the total.
In response to questions from Bloomberg, a Hongqiao spokesman said there have been no redundancies, early retirements or forced holidays at the company.
In its latest report based on anecdotes on the economy gathered from more than 3,000 firms, China Beige Book found that progress on reducing debt and industrial capacity is proving elusive.
Steel plants are still increasing output while they can ahead of a separate set of temporary, winter-time production curbs designed to lower pollution. That may be because remaining furnaces are working overtime.
Morgan Stanley estimates net capacity reductions of steel - accounting for new plants as well as those shuttered - will reach nearly 200 million tons in total for 2016 and 2017 combined. That exceeds Japan's capacity of 130.5 million tons, and is not far off the European Union's 222 million tons.
The country's last wave of mergers and closures of moribund state enterprises, in the late 1990s under then-premier Zhu, cleaned up corporate balance sheets, improved efficiency, and paved the way for the following decade's economic boom, said head of macro research Cui Li at CCB International Holdings in Hong Kong.
The seasonal campaign may shave up to 0.25 percentage point off growth during the next six months, estimates Societe Generale. In July, the Ministry of Environmental Protection said up to 176,000 businesses would be forced to shut down in Beijing, Tianjin and Hebei by the end of September.
As the Party Congress approaches, there is still a question mark hanging about the country's longer-term industrial and environmental policies.
"In the short term, stricter environmental regulations are bound to slow growth," said Mr Frederic Neumann, co-head of Asian economics research at HSBC Holdings in Hong Kong. "The coming leadership re-shuffle offers an opportunity to revisit the medium-term policy agenda. This may entail an even sharper focus on environmental issues and the managing of potential risks in the financial sector."
Even before the crackdown on polluting companies gained momentum in recent months, efforts to reduce industrial capacity had exceeded many analysts' expectations. It fuelled a rally in global metal prices, a surge in China's factory profits, and a frenzy over commodity stocks. Consolidating industries account for half of total fixed-asset investment, according to CCB's Ms Cui. The materials industry, including iron and steel, has been hardest hit, she said.
Shandong is among places feeling the most collateral damage, with locals affected by job losses or reduced wages, and left with uncertainty over their futures.
Zouping's Hushan village is a rubber recycling hub that officials shuttered in one sweep last month. Piles of used tires were stacked as high as two stories in many idled workshops, and some factories were locked up, on a Thursday afternoon last month.
At Madam Liu Shuhua's convenience store, located on a quiet road just outside the village, stocks of cigarettes, liquor and snacks are piled high, where once migrant workers snapped them up. Madam Liu said sales have slumped 50 per cent, and she fears that is permanent. "It's impossible to say I'm not worried. At least half the township population is affected by these closures," she said.
Some hope that workshops will reopen after passing environmental reviews. Mr Liu Qingyong's family of six made 6,000 yuan a month recycling old tyres but now has no income, he said."The closures are all temporary. Sooner or later it will all start again," he said.
The township is trying to find a way out for the rubber workshops, and has invited a Beijing company to discuss a plan, according to a statement on its website. "Closures are not the ultimate solution, but innovation and a clean environment are necessary," it said.
"If Xi is going to maintain support for the Party among China's middle class, he'll need to focus on quality of life issues," said Mr David Loevinger, a former China specialist at the US Treasury Department and now an analyst at TCW Group in Los Angeles. "Stronger enforcement on environmental rules is here to stay, particularly in the northeast. I expect it will be a material drag on growth next year."