According to a recent report by BMI Research, China will produce 825 million metric tons of crude steel next year, a 0.5 percentage point increase from 2016—yet will consume 87 percent of this production.
"Despite Western fears of steel dumping, increased production of Chinese steel will serve domestic demand more rather than flood international markets in 2017," the house wrote.
In the last few years, China has moved to shift the economy from heavy reliance on industrial exports to more home-grown consumer demand, with the steel sector frequently cited as ripe for consolidation because of surplus production capacity. At the same time, the pace of growth in China real estate and construction segment relies on keeping the economic engine chugging along.
But as BMI noted, the trend has been for higher production for growing domestic use. This year output increased at a monthly average of 3.6 percent on-year from August to October, amid monthly average export declines of 17.5 percent from a year ago. Chinese steel inventories as a proportion of production were also at a historic low of 8.2 percent in November.
"This is because continued Chinese fiscal support to the construction sector has buoyed domestic industrial metal demand, especially through public-private partnerships in public infrastructure such as airports, water, rail, power and roads and bridges (that will) continue at least until the end of 2017," BMI added.
The domestic demand will narrow the global steel market surplus to 3.2 million tons in 2017 from 10.9 million tons in 2016, BMI forecast. China is both the world's largest steel producer and consumer.
Investment bank Morgan Stanley concurred, saying in a recent report that overall near-term steel demand is "stable and improving."
Analysts noted that "infrastructure spending has been increasing, while reduced property inventories in lower-tier cities should result in a rise in new starts. Globally, many regions are showing signs of improved demand, from the economic recoveries in Brazil and India to (U.S. president-elect Donald) Trump's infrastructure plans for the U.S.," the investment bank added.
The change in scenery is a turnaround from massive overcapacity in recent years, with China coming under fire for dumping steel into the global markets, depressing prices.
Steel prices are already rallying this year on the improved outlook, with prices in China gaining 60 percent. Prices of its raw material iron ore have doubled on the back of expectations from Trump's massive infrastructure stimulus plan, and as China continued to tackle over-capacity through production cuts, as well as leaving inefficient factories to idle.
China is also under pressure to curb production due to rising trade cases against its dumping, Morgan Stanley noted. This will in turn benefit the return on equity in the global steel sector sector to 12 percent by 2020, up from 2.9 percent in 2015.
The bank said it is confident China can achieve its 150 million metric ton permanent capacity cut target by 2020, citing cuts of 68 million tons by November, exceeding this year's target of 45 million tons. The mega merger between Baosteel Group and Wuhan Iron and Steel, and regional consolidation plans, also point to improved fundamentals in the next three to five years, it added.
Morgan Stanley said steel stocks in China, Japan, India and Brazil have 20 to 40 percent more upside, alongside those in the U.S. Top picks include Angang H & A and Maanshan H in China; US Steel, AK Steel and Steel Dynamics in the US; and ArcelorMittalSA and SSAB in Europe.
Ratings agency Standard and Poor's said results will come in the long run, so there will still be "short-term pain" in the domestic steel industry amid cash flow issues and debt.