China's sputtering construction projects and a sudden drop in steel prices could halve 2012 output growth in the world's top producer of the metal, after major steelmakers defied credit tightening and wafer-thin margins to churn out record volumes this year.

While the central bank's battle against inflation has choked off funding for new buildings, roads and railways, talk of Beijing adopting an easing monetary cycle or lifting property curbs is premature, analysts say, although authorities could seize the chance to force consolidation of the sector.

"Steel demand is very poor," said Judy Zhu, an analyst with Stanchart Bank in Shanghai.

"There is hardly any restocking going on because buyers are cash strapped and there are growing worries of a further slowdown in the property sector.

"I don't expect Beijing to start easing until early next year, which means it would be difficult for steel demand to improve markedly."

UBS analysts said steel output growth in China could slacken to just 4.4 percent for a total 726 million tonnes in 2012, marking the weakest level since 2008 and down sharply from industry estimates of 11 percent this year.

Such a development, compared with some analysts' previous expectations for growth of 7 percent to 8 percent, would cut previous output forecasts by about 20 million tonnes, which would in turn cut iron ore consumption by at least 35 million tonnes and coking coal by 13 million tonnes.

The impact of such a slowdown could be far reaching.

It would mean a combined loss of some $8 billion in sales of iron ore and coking coal for miners such as the world's top three iron ore producers Vale SA (VALE5.SA), Rio Tinto Ltd (RIO.AX)(RIO.L) and BHP Billiton Ltd (BHP.AX)(BLT.L).

It could stiffen headwinds for economies such as Australia and Brazil, key producers of steel-making raw material iron ore, whose fortunes are closely tied to China.

Evidence of a slowdown is mounting. The price of rebar used by the construction sector has tumbled 20 percent since August to a record low, and inventories have also risen for two months as end users slowed orders and daily steel production has already begun to ease.

THE BIG LIQUIDITY MOP

A series of rate rises by the People's Bank of China to rein in lending and trade financing has pushed China's banks to hike lending rates for short-term financing.

Higher borrowing costs have thrashed traders, a crucial sales channel for China's steel mills, with costs of financing having tripled to around 80 yuan ($13) per tonne of rebar.

"Steel traders used to rely on short-term financing tools to improve their cash flow. But a bunch of traders from Wenzhou city and Fujian province have been forced to drop out of the financing circle," said a small steel trader in Shanghai.

Wealthy traders from Wenzhou and Fujian make up a sizeable portion of China's steel traders, whose hub is Shanghai. There is no official data on how many steel mills operate, as many run without licenses, but there are estimated to be at least 1,500.

Higher up the demand chain, difficulties faced by property developers in securing loans have led to the postponement of some construction projects, which now plan to enter the market after the government relaxes its curbs.

Investment growth in China's real estate sector, which makes up 42 percent of total steel demand, cooled sharply to 25.0 percent in September from a year earlier, compared with a rise of 31.6 percent in August, according to the National Bureau of Statistics.

Local governments, too, have not been spared.

China's road building plans face unprecedented capital shortages, with some provincial governments failing to pay engineering firms for two to three months in succession, the official People's Daily reported this week.

A major train crash in August and scandals at the rail ministry have also led to a near collapse in new rail investments, forcing work on more than 10,000 kilometers of rail projects to be suspended.

As one kilometer of rail uses about 920 tonnes of steel, consumption of about 9.2 million tonnes will be delayed by this move.

"Spot trade has almost ground to a halt in parts of China," said a second steel trader in Shanghai. "The lack of funds, coupled with uncertainty over the global economy, are reasons behind the slump in steel prices."

January Shanghai rebar futures slumped to a contract low on October 20 and is down about 7 percent so far this month. The contract has fallen around 20 percent from where it started trading in January.

The yuan currency has risen around 4 percent so far this year, dealing a third whammy to Chinese steel export, some five percent of the country's total steel products output.

"Export orders are very fragile, due to weak demand from Europe, and the high yuan has also largely eaten into our price advantage compared with other countries," said a senior steel exporter in Beijing.

TOO EARLY TO CALL FOR EASING?

But with inflation still around 6 percent and some economic indicators, including industrial output, fixed-asset investment and retail sales, still showing robust growth, Beijing may have little room to relax monetary policy soon.

The government may use targeted loosening to save some of its small- and medium-sized enterprises (SMEs) in the near term, but in the unruly steel sector, long singled out for consolidation, Beijing may well let market forces finish the job.

"This is a rare opportunity to force those inefficient steel mills to close. It would be a painful process but there won't be a better time," said an analyst at an investment bank who did not want to be identified as he is not authorized to speak to the media.

"Have a look around and you'll find flights are still full and companies are still complaining of rising labor costs. This isn't an economy that is in need of easing yet, unless the situation worsens sharply in Europe."

But there are surprises aplenty in China's murky economy, and there are many levers the government can pull to revive the steel sector, should the slowdown be too swift and too sharp.

A potential policy easing in interest rates or banks' required reserves could give a boost to infrastructure investment, while the construction of social housing, with some 10 million units planned in 2012, could bring upside surprises.

Any moves to speed investments planned under the five-year development timetable, such as the development of western China, would also give steel demand a lift.

"A lot of the problems this year stem from the liquidity crunch. So, as long as Beijing starts easing, possibly next year, the steel industry would quickly be revived," said Wang Dezhi, an analyst with Orient Futures in Shanghai.