However, its longstanding problems with excess production capacity are being exacerbated in the current downturn. Orders from downstream processing clients reduced significantly from mid 2008 onwards. Iron and steel consumption is forecast to reach 427 million tons for 2009, but this is well within the industry's estimated total capacity of more than 500 million tons.

 

Moreover, weak export markets, particularly in key sectors such as automotive, mean the recent slowdown is unlikely to be quickly reversed. Direct and indirect exports of iron and steel products constitute 23 percent of China's production capacity.

 

The fragmentation of the domestic iron and steel industry has hindered the creation of competitive or powerful players in the global market. This has been especially challenging for Chinese enterprises dealing with international iron ore suppliers. The relatively small scale of many companies has created challenges in maintaining the quality of production and enhancing their management and sales skills.

 

Despite its fragmented state, the sheer productive scale of the domestic industry means that any M&A activity involving Chinese iron and steel companies still has the potential to significantly affect iron and steel markets at a global level. Major M&A or restructuring activities during 2008 include Baosteel's acquisition of Bayi Iron and Steel, the establishment of Guangdong Iron and Steel Group and Hebei Iron and Steel Group, and the merger of Tang Shan Steel Group and Handan Iron and Steel Group. These represent big steps forward for the iron and steel industry, as China seeks to build stronger and more globally competitive enterprises.

 

New industrial policies and macroeconomic adjustments are creating opportunities for further M&A across the industry in the years to come. International players cannot afford to ignore these domestic developments.

 

The downturn may also drive this trend towards consolidation. With production costs rising, competition is becoming fiercer. The market price of iron and steel started to drop in August 2008 before plunging in September; production capacity also declined as the fallout from the global financial crisis started to be felt.

 

The market price for raw steel also fell gradually throughout the second half of 2008 and into 2009, after peaking at 161.5 points at the end of June 2008. China now faces an uneasy mix of high production costs and low demand that could threaten the survival of many enterprises, but also provides room for M&A and restructuring activities within the industry.