* EU business group says overcapacity harming China, world
* Warns of rise in anti-dumping cases, drop in FDI
* Yuan is not cause of problem but may be part of solution
(Recasts after news conference to launch report)
By Alan Wheatley, China Economics Editor
BEIJING, Nov 26 (Reuters) - China faces a protectionist backlash next year because its manufacturers are saddled with overcapacity and are offloading excess output into world markets, the European Union Chamber of Commerce in China said on Thursday.
Joerg Wuttke, the head of the business group, said it takes about 12 months to prepare a case alleging dumping, the practice of selling goods for less than it costs to produce them.
"This lead time would indicate to me that in the second half of 2010 there will be far more dumping cases against China, unfortunately," Wuttke said.
He was speaking at the launch of a study into industrial overcapacity in China, a long-standing scourge that the chamber believes has grown more serious as a result of the global financial meltdown and Beijing's aggressive response to it.
"The crisis has throttled demand for exports from China at a time when even more investment, in the form of the Chinese government's massive stimulus package, is being pumped into building new plants and adding unnecessary capacity.
"As a result, the problem is actually getting worse in many industries," the report said.
In a survey of the chamber's members, 56 percent of respondents identified local government policies aimed at luring investment as the main macroeconomic reason for overcapacity; loose lending was the second most frequently cited cause.
Wuttke welcomed efforts by the central government to curb new capacity, but said it was often powerless in the face of local governments that crave new factories for the tax revenues and jobs they generate and that do everything to keep existing plants from going under.
"Local protectionism kicks in. So even if Beijing sees a problem and wants to tackle it, they are very often derailed by local politics," Wuttke said.
Apart from generating trade frictions, rampant overcapacity would weigh on foreign direct investment into China. "Why would you invest if that market is already oversupplied?" he asked.
SWEEPING SOLUTIONS
By wasting resources and eroding profits, overcapacity deters research and development and encourages firms to cut corners on health and safety standards as well as environmental protection.
Further, the creation of unneeded capacity raises the risk of non-performing loans for banks that finance the investment. It also generates trade tensions as producers offload their surplus production overseas at cut-rate prices, the study said.
The State Council recently singled out iron and steel, cement, electrolytic aluminium, glass, coal chemical, polysilicon and wind power equipment as the worst offenders when it came to overcapacity and announced steps to rein in their expansion.
The Chamber applauded the cabinet's actions but said the fundamental answer was to shift from investment- and export-led growth and to focus more on domestic consumption and services.
The report made a series of recommendations that amount to a root-and-branch overhaul of China's economic model. They include:
-- Redistribute national income from firms to households; state-owned enterprises should disgorge dividends for the government to spend on social security, health and education instead of ploughing profits back into fresh investment.
-- Slash corporate capital expenditure in coming years.
-- Remove subsidies for energy and other inputs, provided indirectly by households, to which manufacturing has become addicted; increase resource and environmental charges.
-- Raise interest rates to reflect the real cost of capital and let the yuan, or renminbi (RMB), gradually appreciate.
"The RMB for me is not a cause of overcapacity but it could be a way to tackle overcapacity," Wuttke said.
For an analysis on overcapacity, click on (Reporting by Alan Wheatley; Editing by Jonathan Hopfner) ((alan.wheatley@thomsonreuters.com; +86 1391 007 9146; alan.wheatley.reuters.com@reuters.net)) ((If you have a query or comment on this story, send an email to news.feedback.asia@thomsonreuters.com))