SHANGHAI/BEIJING (Reuters) - As China slims down its bloated steel sector, the western region of Xinjiang is feeling the pain even more than the industry’s heartland to the east, threatening efforts to develop a restive area that is home to the mostly Muslim Uighur people.

An employee works inside a steel factory in Kashgar, Xinjiang Uighur Autonomous Region, China, March 10, 2013. REUTERS/Stringer

Over 10 million tonnes of steel production capacity in Xinjiang - enough to produce about a tenth of annual U.S. output - has shut in an area where Beijing has encouraged investment in industries ranging from steel to textiles, in the hope of stimulating growth and curbing unrest by boosting jobs.

The decline in the fortunes of Xinjiang’s steel sector highlights the challenge Chinese policy makers face ensuring job cuts do not strain social cohesion or undermine stability.

China aims to lay off 5-6 million workers over the next two to three years in the country to curb industrial overcapacity and pollution, and will spend nearly 150 billion yuan (£16.2 billion) to cover layoffs in just the coal and steel sectors, sources told Reuters.

"The situation is very severe. There are many newly built steel mills being closed and steel prices have tumbled," saida sales official at a unit of Xinjiang Ba Yi Iron and Steel Co., Ltd 600581.SS, noting the unit was losing 300-400 yuan ($45.95-$61.27) a tonne.

The official declined to be named because he was not authorized to speak to media, but at least seven mills were built in western regions under Beijing’s investment drive.

Thousands of steel jobs are estimated to have gone in Xinjiang after some “irrational” investments from 2010, said Chen Ziqi of China International Engineering Consulting Corporation.

Human resources’ minister, Yin Weimin, said on Monday that China expects to lay off 1.8 million workers in the steel and coal sector, or 15 percent of total.

But Xinjiang is particularly vulnerable given its relatively sparse population and limited export opportunities, even with China’s ambition to create a new Silk road and economic belt stretching from Western China to Central Asia and Europe.

“Xinjiang’s location is a big problem. Its internal demand hasn’t picked up sufficiently to match the expanded capacity,” said Jiang Feitao, a policy researcher at the China Academy of Social Sciences, a state thinktank.

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SOCIAL IMPACT

With Beijing leading a “war on pollution”, traditional steelmaking provinces such as Hebei in the north and Shandong in the east are seen as priorities to cut capacity, but Xinjiang has suffered far more so far.

This could concern Beijing, which has blamed violence in the area on Islamist militants seeking an independent state for Uighurs.

With most of the workforce in Xinjiang’s mainly northern steel mills Han Chinese, the closures are unlikely to have any immediate impact on stability, though Beijing will monitor the situation closely, experts say.

“Any time there is a decline in employment it will have some kind of social impact, even if it’s the case that not very many people lose their jobs, because it will mean diminished prospects for future employment,” said Barry Sautman, an expert on China’s ethnic politics at the Hong Kong University of Science and Technology.

Xinjiang’s 2015 steel output tumbled 39 percent to 7.40 million tonnes, National Bureau of Statistics (NBS) data showed, while industry sources said capacity utilization had fallen as low as 30-40 percent versus a nationwide average of 65-70 percent.

On the other hand, despite promising to cut capacity by 60 million tonnes over 2013-2017, Hebei’s 2015 steel output rose 1.3 percent to 188.3 million tonnes, according to NBS data.

“Given the premium on stability in Xinjiang is even higher because of the ethnic issues, then the government will try to ensure there is no visible social tension coming out of this,” said Nicholas Bequelin, Amnesty International’s East Asia director and an expert on Xinjiang.

JOURNEY TO THE WEST

The prospect of new steel demand in China's central and western regions was also used by miners such as Rio Tinto RIO.AXRIO.L and BHP Billiton BHP.AXBLT.L to justify expansion, creating an iron ore glut that has sent prices .IO62-CNI=SI plunging 60 percent in two years.

Xinjiang had planned to more than triple crude steel capacity to 32 million tonnes by last year, but capacity may have exceeded 40 million tonnes before the latest closures, according to industry website Lange.com.

Xinjiang Ba Yi Iron & Steel Co Ltd, a subsidiary of Baosteel Group, shut 3 million tonnes of capacity last summer and Reuters calculations based on reported mill closures show that more than 10 million tonnes has been lost since 2013.

Xinjiang’s Communist Party chief, Zhang Chunxian, told media in January it would not approve new projects and stop subsidising inefficient plants or power prices.

The province also aims to shut another 3 million tonnes of capacity over the next two years.