A market exit mechanism must be put in place as the steel industry strives to cut excess capacity, China Iron and Steel Association said on Friday.

"Though some enterprises have either cut or stopped production, the absence of an exit mechanism has prevented them from withdrawing from the market completely," the association said.

"Some have become 'zombie enterprises' due to a lack of funding, but are still there."

Some local governments still request those enterprises to maintain production to ensure social stability and local economic growth, the association said.

China's iron and steel industry has hit a soft patch as the general economy and decades of building boom are slowing. The country's production of crude steel fell 2.3 percent to 804 million tonnes in 2015, the first time the industry reported negative growth in 34 years.

China will cut crude steel production capacity by 100 to 150 million tonnes in five years, the State Council said last week.