After the initial crash in many of the commodities backing China's shadow-banking system's ponzi [7], levels recovered modestly as rumors were spread of bailouts, stimulus, and in fact the exact opposite of what the Chinese government had declared it was trying to do. That ended for Iron Ore this weekend when, as The FT reports, [8] China announced plans to get tougher on loans for iron ore imports as concerns grow that steel mills are using import loans to stay afloat in defiance of policies to reduce overcapacity in heavily polluting and lossmaking industries. Iron Ore prices tumbled overnight, closing near the lowest levels since Sept 2012 as it appears the PBOC and CBRC are serious and set to implement the tougher rules on May 1st.
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As The FT reports, [8] The China Banking Regulatory Commission warned banks to tighten controls over letters of credit for iron ore imports in a document that caused iron ore futures in China to drop 5 per cent on Monday. Rumours of the stricter measures, which are expected after the May 1 holiday, have been circulating in China for at least two months, after a hasty stock sale caused ore prices to tumble in late February.
Steel mills and traders have used iron ore imports to raise money as other sources of credit dry up, in yet another channel for off-book or “shadow” financing.
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Chinese firms have developed a number of creative channels for raising money thanks to years of capital controls meant to starve the real estate sector of speculative funds. But the bulk and difficulty of transporting iron ore makes it a cumbersome material for raising money, limiting its flexibility as a financing tool compared with copper or gold.
But it's clear, the mills are unable to stop for fear of what the consequences are...
Data from the first quarter of the year show that China is on track to produce 822m tonnes of steel this year, a rise of 5.5 per cent from last year’s output, despite the rising debt levels, increased financing costs and the prospect of more environmental regulation.
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Regulators are worried that the collapse of a heavily indebted mill could endanger a chain of local bank branches and even local governments, since steel mills are often the largest employers, taxpayers and debtors in their area. A case in point is Haixin Steel, also known as Highsee, which the local government in Shanxi province is trying to save.
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The extra capacity flies in the face of a political campaign to close some polluting plants in Hebei province, which surrounds Beijing, to meet targets meant to reduce pollution around the capital. The trade-off for Hebei, which fears the loss of jobs and local tax income, is greater regional integration with Beijing and Tianjin, a large northern port city.
And therefore...
China plans to get tougher on loans for iron ore imports as concerns grow that steel mills are using import loans to stay afloat in defiance of policies to reduce overcapacity in heavily polluting and lossmaking industries.
The major problem, of course, is any restriction or tightening is necessarily lowering the price of the iron ore... thus reducing the value of collateral and thus worsening credit conditions in a vicious circle as firms can borrow less and less actual Yuan against their inventory at a time when cash flows are becoming increasingly negative from demand collapse.