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The collapse of China’s steel market has reverberated around the world: benchmark prices for iron ore, a key steelmaking ingredient, have dropped to three-year lows of $89 a tonne, down 24 per cent in the past month alone. China accounts for about 60 per cent of global imports of iron ore, a market worth more than $100bn annually worldwide and one that is essential for the profits of global mining houses such as BHP Billiton, Rio Tinto and Vale of Brazil.

But countries that sell commodities to China, such as Australia, are warning that the party is over, and global mining houses are scaling back investment plans because of slowing Chinese demand.

At ground level, steel mills and iron ore traders in China say they do not see a clear light at the end of the tunnel. A key reason behind the sharp drop is China’s slowing economic growth, down from double digits over the past decade to 7.6 per cent in the second quarter of this year.

Wang Qinghai, chief executive of Shougang, one of China’s biggest state-owned mills, says one reason for slowing steel demand is that China is changing its economic development model. “The investment-led mode of economic development isn’t sustainable, so the government is actively lowering the growth rate . . . in order to create space for economic structural adjustment,” he said at a conference in Beijing on Saturday.

That adjustment is a painful process, however, and Mr Wang summarises the outlook for the steel industry as “huge production capacity, a bleak market, and meagre profit”.

Layered on top of that structural shift, the precipitous drop in iron ore prices over the past few weeks has been triggered by tightening bank credit policies that are forcing traders to sell their stockpiles into the falling market because they can’t extend their loans. This year, China’s bank regulator warned banks of rampant illicit borrowing by steel traders, who had used steel as collateral and then borrowed money to invest in real estate or the stock market.

Traders say that these restrictions have had a big impact. Some independent iron ore traders are having to liquidate their stockpiles at losses of $50 to $60 a tonne because they cannot get loans, according to a broker in Hong Kong. “If you look at the books at current prices there probably aren’t many that aren’t bankrupt,” he adds. China’s iron ore stockpiles at ports hovered near record highs for most of this year, but analysts say that stockpile levels across the country are starting to come down as inventory adjustment takes place.

Steel traders are also finding themselves in a desperate position. “We have to try every possible means to sell [our steel] even if we lose money. We will lose more if we don’t sell,” says a trader with a large steel trading company in Henan province.

Another reason for the slump in China’s steel markets is the unique structure of China’s state-dominated steel sector. This year Chinese mills have maintained high levels of steel production – even when running at a loss – rather than shutting down their furnaces, because many state-owned mills are incentivised to maximise revenues instead of profit. Revenues from steel mills means more tax revenues for the local government, their ultimate owners.

Policy makers say state support for the steel sector has allowed some less efficient mills to stay afloat. “There is too much control of steel by government,” says Jiang Feitao, a deputy director specialising in steel at the prestigious Chinese Academy of Social Sciences. But he adds: “If [the current situation] lasts long, it will force the state-owned enterprises to reform.”

If there is a light at the end of the tunnel, it is that China’s economy has not completely come to a halt: urbanisation is continuing, buildings are still being constructed, and big new railway projects are slated for the autumn. All of these programmes will require steel, and China’s steel demand growth is still expected to be positive this year. But because of the structure of China’s steel market, the adjustment from fast to slow growth is not going to be an easy one.