Over the last couple of weeks, the Chinese government has been introducing a series of relatively small yet significant reforms targeted at improving the prospects of the country’s ailing solar sector. In this note we take at a quick look at some of the key developments and how they could potentially impact the industry.
Limits On Capacity Expansion Bodes Well For Consolidation: In mid-September, China’s Ministry of Industry and Information Technology said that it will not allow construction of new solar manufacturing facilities that are intended to “purely” expand capacity.  We believe this move is intended to bring about consolidation within the solar industry since healthier solar companies which are seeing strong demand will be encouraged to absorb manufacturing assets from distressed companies rather than adding to China’s already massive and underutilized solar manufacturing capacity base. China alone has close to 50 gigawatts (GW) of annual solar manufacturing capacity while global demand for solar panels this year is just about 35 GW. However, we believe that the success of this regulation will hinge on whether China’s regional governments first allow weaker solar companies to fail so that they can be acquired by healthier firms.
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Minimum R&D Spending Requirement Can Help Improve Product Quality: The government now requires all solar equipment manufacturers to spend a minimum of 3% of their annual revenues or the equivalent of $1.65 million towards research and development as well as technological advancements.  Although some tier-1 Chinese manufacturers such as Trina Solar (NYSE:TSL) have been producing technologically differentiated products and already spend close to 2.5% of their revenues on R&D, most others tier-1 companies have been focusing on incremental improvements to their manufacturing processes rather than on product-related R&D. Tier-2 firms on the other hand employ less sophisticated technology and their products remain largely commoditized. We believe that the move to impose minimum R&D spending requirements is a positive first step in improving the overall product standard in the Chinese solar industry.
New Tax Breaks Positive, But Could Raise A Red Flag In Export Markets: Earlier this week the Chinese government introduced new tax breaks for the solar industry. China’s Ministry of Finance said that all solar power products will receive immediate refunds of 50% of value-added taxes.  The move will benefit Chinese solar firms by lowering their overall costs and improving their competitiveness. However, there are risks that this could be viewed by foreign governments of countries where Chinese solar products are exported as being a subsidy since these tax breaks are specific to solar companies.  Chinese solar companies already face countervailing duties on their exports to the United States where they have been accused of receiving unfair subsidies from the Chinese government.Notes: