"If immediate measures are not taken to deal with current overcapacity, vicious competition will spread and intensify, leading to expanded losses, a higher unemployment rate, growing non-performing assets and damage to the environment," the State Council warned in the guidelines.

To fight against the global financial crisis, policies have been put in place to expand domestic demand and promote economic growth since 2008. Local governments were motivated to start infrastructure projects, building roads, bridges and airports, while the number of ghost cities and towns bloomed across the country.

At an executive meeting of the State Council held on June 19, Premier Li Keqiang showed support for cutting capacity and proposed issuing loans for mergers and acquisitions to those enterprises that cut excess capacity. He said loans would be denied to illegal construction projects involving industries with overcapacity.

"The guidelines are a reminder that overcapacity has bred myriad contradictions and problems for China's economic development," said Li Xinchuang, Deputy Secretary General of China Iron and Steel Association.

"To deal with the problem, China has to go through a period of struggle, and some industries will be hit hard," said Zhu Baoliang, an economist with the State Information Center, who added that measures should be taken to guide investments and accelerate industrial upgrading.

Possible responses

In the guidelines, curbing blind capacity expansion is mentioned as a top priority. Luo Tiejun, Deputy Director of the Department of Raw Materials of the Ministry of Industry and Information Technology, stressed that combating overcapacity could be done in three ways: refusing new projects that may add to overcapacity, strictly controlling and monitoring projects under construction, and liquidizing remnant assets. Local governments should be more accountable when trying to get approval for new projects.

"While the market should be given full play, local governments should keep in mind that they are walking a tightrope," said Ren Haoning, a senior research fellow from China Investment Consulting Corp.

Worth mentioning is that specific solutions were drawn up for different sectors. For the steel sector, focus is put on better coordinating dispersed production capacity. Other measures include advancing product standards for rolled steel like hot rolled ribbed steel bars and electrical steel, and carrying out fair tax policies.

For the glass sector, improvements need to make in glass product standards, such as promoting low-radiation hollow glass and upgrading existing production lines. Efforts should also be made in integrating production with the deep processing of glass sheets and increasing core competitiveness.

The release of the guidelines indicates that China intends to carry out reforms, said Li Xinchuang, of the iron and steel association. It illustrates the Central Government's resolve to reverse its GDP-oriented assessment for local governments and further decentralize power.