The government is working to improve China's photovoltaic solar industry by encouraging distributed power generation, or the use of small energy sources such as solar panels and wind turbines, the State Council said on Wednesday.

The meeting, led by Premier Wen Jiabao, said Chinese photovoltaic companies are contending with severe overcapacity, a high dependency on overseas markets and financial difficulties.

To reduce the industry's production, the government said it will place limits on projects to manufacture polysilicon and solar modules.

The biggest 150 Chinese makers of photovoltaic modules had the capacity to produce 40 gigawatts worth of the devices this year, according to public information. Yet, throughout the world, there is only enough demand to support the production of 20 gW to 40gW of the products a year in 2012 and 2013, according to European Photovoltaic Industry Association estimates.

As much as 70 percent of China's PV solar modules are now exported to Europe and about 10 percent to the United States.

To help the industry reduce its dependency on foreign markets, the government has promoted the use of distributed power generation in China.

Officials at the meeting said the government is encouraging companies and communities to install photovoltaic solar-power projects.

"The most important thing is to expand the domestic market," said Meng Xian'gan, deputy director of the China Renewable Energy Society.

"And distributed solar-power generation will allow the industry to develop so long as grid connection problems are solved."

State Grid Corp, China's largest State-owned power utility company, began in November to provide a service that allows distributed photovoltaic solar-power producers to connect to the national grid for free.

The meeting called on China to set up efficient grid connection services and improve its setting of electricity prices.

The country will also subsidize distributed solar-power generation and regulate the benchmark price of solar electricity in various places according to weather and geographic conditions.

A National Energy Administration plan calls on China to have 15 gW of distributed solar-power generation capacity by the end of 2015.

Meanwhile, a trade war between China and its largest solar market, the European Union, has grown fiercer since November, when the United States announced it would place punitive tariffs on imported Chinese solar products.

Many small and medium-sized producers of solar cells have gone bankrupt after seeing the number of orders they received from foreign markets decrease.

And more than 80 percent of the 43 polysilicon companies in the country have stopped production in response to a decline in prices and order numbers.

"Although the government is working hard to help the industry persist, the companies still need to rely on themselves and adjust their plans to the new changes," Meng said.

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