A wall against crisis?

26 March 2001 00:00  [Source: ACN]

In a special two-part feature, John Richardson and Malini Hariharan first of all try to tackle the big question - just how strong will China's GDP growth and its demand for petrochemical imports be in 2001? The second part outlines why the strength of China is so important this year. We profile the problems facing some of Asia's other petrochemical markets

The burning question this year as the rest of Asia reels from the impact of slowing growth is to what extent China can keep out the global economic crisis.

Will China's economy continue to expand at close to the rate of 2000 or will the impact of the US slowdown and problems specific to this country lead to a sharp fall in GDP (gross domestic product) expansion?

Perhaps a more relevant question might be whether, in 2000, China's economy did actually expand at the rate indicated by the official GDP figure. If the figure has been exaggerated, should several percentage points be shaved off the government GDP number which will be produced for 2001?

And what about petrochemical exports? How will they be impacted by the macro economy and what trends can be picked up from last year and from the first few months of 2001?

To return to China's overall economy, it is the usual case that if you put two economists in one room, you will get 27 different opinions.

The economists at Deutsche Bank share one opinion on China, that this year, its economy will remain relatively stable with only a small reduction in GDP growth to 7.7% from the official figure of 8% for 2000.

The bank argues that China's accession to the World Trade Organisation (WTO), which is likely to occur this year, will deliver an immediate benefit to labour intensive industries such as textiles, apparels and electronics through greater access to export markets.

However, the telecommunications and financial industry and other service industries will suffer from being opened up to foreign competition.

From 2001 to 2005, Deutsche Bank estimates that China's GDP growth will each year be boosted by 0.45% due to WTO membership.

One immediate effect of the imminent admission is the surge in foreign direct investment (FDI). Economists say that FDI commitments in 2000 rose by 50% over 1999. The bulk of these commitments will become a reality this year, resulting in an FDI spending total of US$47-40bn against US$41bn in 2000, they add.

And the economists point to technology transfer and China focusing on the industries in which it enjoys competitive advantages, a necessity for it to thrive after admission, as reasons why the WTO is already delivering an economic boost.

China in 2000 claimed 30% of the developing world's FDI and more than 50% of that which was either spent in or committed to Asia.

And Deutsche Bank and other economists add that the liberalisation of consumption and competition policies, which includes the reduction in regulatory fees and the removal of domestic trade barriers, should boost demand for housing, automobiles and telecommunications.

Also, China is no longer suffering from deflation. The Consumer Price Index (CPI) rose by 3.1% in November of last year compared with the same month in 1999.

Between January and December of last year, the CPI grew by 1.5% and there are hopes that this year inflation will reach 2%.

The return to inflation is partly the result of the reflationary policy of the Central Bank - it has made six successive interest rate cuts.

Consumer and business confidence appears to be high, the highest since domestic indices measuring the confidence were created two years ago.

There is also the wealth effect of housing reform and the surge in the domestic stock market.

More than 30% of domestic apartments in urban areas have been transferred to private hands and this process will be accelerated over the next 1-2 years.

The value of China's A-share market surged by 50% in 2000 with the Shanghai B shares increasing by 136%. The next best performing market in the world in 2000 was Ireland's which rose by 14%.

And then there are the government's economic stimulus packages. In 2000, these greatly helped boost domestic demand and this year the government appears to have plenty of room to inject further life into the economy.

In Japan, government debt is estimated to be 100% of the country's GDP; in Indonesia, 56%; in Malaysia, 74%; and in the Philippines and Thailand, 56%.

However, the government debt-to-GDP ratio in China is only 21%, the result of a 20% surge in government revenues in 2000 due to the strong economy, the introduction of a tax on interest income and the antismuggling crackdown.

The government intends to take advantage of the space it has for further economic stimulus.

China announced earlier this month at the annual National People's Congress that its draft 2001 budget includes issuing Rmb150bn (US$18.2bn) of construction bonds and special bonds. These will mainly be used to boost the country's relatively impoverished western region.

The draft budget also contained a 21.4% increase in agricultural spending and more cash for local governments through a 10.9% increase in the amount of money transferred from Beijing to the provinces.

The emphasis on developing the west is further official recognition of the desperate need to close the huge economic gulf which is widening between much of China's interior and its wealthy eastern coastal region.

In 1999, for instance, the per capita income in Shanghai was Rmb30 800 against Rmb2475 in Guizhou, China's poorest province. National Bureau of Statistics preliminary figures for 2000 show that urban per capita income rose 7% while in rural areas, the increase was only 2%.

Another pointer to the wide gap between the west and the east is that many westerners do not even have fixed-line phones, hence the government's intention to spend heavily on telecommunications this year in addition to roads and bridges to better link the interior with the east coast. China's mobile-phone ownership is increasing by 200%/year, which is almost entirely down to the east. There are now approximately 90m mobile-phone users in China.

But what about the impact of the US slowdown on China's export trade and therefore its GDP growth?

Deutsche Bank argues that although China's GDP-to-export ratio at first glance seems quite high at 23%, a large proportion of these exports are of low value-added components which are assembled in locations such as Hong Kong for final shipment. Therefore, it estimates that China's real GDP exposure to exports is closer to 13-14%.

In countries such as Singapore, Malaysia and Taiwan, GDP exposure to exports is very high because of the huge wealth generated from high value-added electronics exports which mainly go to the US.

Also, the 23% is in itself not that relatively big. Asia's average GDP exposure to exports is more than 50%.

Deutsche Bank and several other economists also point to China's huge domestic market as a buffer against a US slowdown. They argue that much more important than the global economy to China will be the success of its macroeconomic policies.

The economists, therefore, estimate that although China's export growth is this year likely to slow to 8% from 28% in 2000, this would shave only 1% of GDP growth. Therefore, even if export growth slipped to zero which is considered highly unlikely, GDP would only be adversely affected by 1.5%.

The more pessimistic of the economists do not disagree with the long-term benefits that WTO membership.

However, they say that, in the short term, the impact on industries such as the automobiles and pharmaceuticals will be very painful.

The market for public-sector vehicle purchases and taxis has reached saturation point and the expectation is that greater competition resulting from WTO membership will drive prices even lower.

The economists add that the removal of regulatory fees for automobiles will only partially offset the negative WTO impact.

Painful consolidation will be necessary in pharmaceuticals, they say. The industry is looking to form groups with sales revenue of at least Rmb10bn.

Earlier this month, Sinopec announced that it may this year reduce its 511 800 workforce by 27 000. The cut would be part of a preliminary plan to lower its manpower by 100 000 from 2001-05.

China National Petroleum Corp (CNPC) intends to eventually reduce its workforce to 1.19m. In September 1999, its labour force stood at 1.54m people.

Sources say that the pressure on Sinopec and CNPC to cut jobs by even more will intensify as a result of liberalisation brought about by WTO membership.

The government faces a difficult balancing act. The pace of reform has to be sufficient to satisfy the WTO without denting growth. Since 1998, an estimated 24m people have been made redundant from state-owned enterprises. Statistics such as these show the threat to growth from the reforms which have already taken place.

And not all sectors of China's economy are booming.

Take agriculture as an example. Agri-cultural growth was just 2% in Q4 of last year, 0.2 percentage points lower than the third quarter because of severe droughts.

Summer grain output in 2000 was 11m tonne lower than in 1999, while the autumn harvest also declined.

The government is pushing for further crop and output restructuring and in 2000, production of higher margin crops rose by 13%.

Agricultural markets remain oversupplied and therefore, there is severe downward pressure on prices.

Life in the countryside is being made even harder by widespread corruption, say commentators. Local officials arbitrarily create and levy taxes which have led to social unrest.

The CPI might have returned to the positive, but the more pessimistic economists say that despite all the government spending, there has yet to be a consistent upswing in retail demand.

Retail sales did rise by 10% in Q4 of last year to a total of US$118bn. However, the percentage growth was 1.2 percentage points lower than Q3 and 1.2 percentage points lower than the second quarter.

Also, the overall retail price index fell by 1.4% in Q4 with prices for medical products, transportation and entertainment services all falling.

The problem in China is that there is massive oversupply in many industries. For instance, there is an estimated 50% oversupply in electronic goods.

State directed lending to state-owned enterprises which have bad financial management has led to not only overcapacity, but also very poor quality products, say the economists.

In addition, the difficulty in extracting payment from domestic end-users compared with the quick and full settlements provided by export customers has made many of the more efficient companies heavily dependent on the export sector.

And the economists add that because contracts for overseas shipments are more easily enforced, China is rapidly becoming a much higher value-added exporter. This suggests that its real export exposure might be higher than the 13-14% estimated by Deutsche Bank.

Textiles and toys are still very important to China's export trade. The Toy Manufacturers Association of the US, for example, estimates that US$9.8bn of the US$14.6bn of toys imported into the US in 1999 came from China.

High-technology exports increased by 50% to US$30bn last year and China's shipments of computer hardware exceeded Taiwan's for the first time.

Mechanical and electrical product exports, a category which includes consumer electronics, rose in 2000 to 42% of total exports from 32% in 1997.

Also, the China Economic Quarterly argues that although China's exports to countries other than the US last year grew faster than those to the US, this does not paint the whole picture. For example, exports to the European Union and Asean countries increased by 39% and 51% respectively against a 30% increase of shipments to the US.

The problem for China is that although the majority of its exports do not go directly to the US, much of its external trade may indirectly end up there. China exports huge quantities of components for finished goods which end up in the States.

There are no figures available as to exactly what percentage of China's exports are indirectly dependent on the US.

What is clear is that 60% of the country's exports are to Asia. Whether or not these shipments are for re-export trade to the States, Asia is being severely affected by the US slowdown.

The decline in China's export growth mirrors the US slowdown. As the world's biggest economy went into decline, China's export growth fell to 14% in November of last year and 8.5% in December from more than 20% earlier in the year.

And one view is that because domestic retail sales growth is still disappointing despite the government's economic pump priming, China has become over dependent on its export trade, no matter what is the truth of its exposure to the US economic deceleration.

Because of the importance of export trade, value-added tax rebates have been increased to close to 100% for textiles, toys, electronics, machinery and shoes.

Last year, there was a record number of antidumping cases against Chinese exporters in the US. An interpretation of this record is that state-owned enterprises are being pressed to sell into international markets without profit. The alternative for them could be no sales at all into a flat domestic market.

Also, for arguments sake, accept the 7.7% GDP forecast for 2001, shave off 1% for the forecasted fall in exports, then remove another 2% for inaccurate economic data and you end up with a GDP growth for 2001 of only 4.7%.

Thomas Rawski, professor of economics at the University of Pittsburg, argues in the China Economic Quarterly that recent research suggests China's long-term GDP growth has been exaggerated by several percentage points.

However, he adds that official figures do understate both the size and the long-term growth of China's service sector.

And Rawski is keen to stress that the National Bureau of Statistics, formerly the State Statistics Bureau, has modernised economic measurement to the extent that there is now a steady stream of generally accurate and comprehensive statistics.

But still, he says that there is evidence that since 1998, a broad array of economic information, including provincial and national growth figures, has fallen victim to jiaboa fukuafeng (wind of falsification and embezzlement).

He adds that official reports of GDP growth of 7.8% for 1998, 7.2% for 1999 and 8% for 2000 appear grossly exaggerated.

The roots of the problem go back to 1993 when China applied fiscal and monetary brakes to cool an overheated economy, Rawski says.

When inflation abated with no major effect on growth, the government welcomed China's soft landing and ignored the sharp reduction in employment growth.

By 1997, when the Asian economic crisis arrived, China was facing a serious un-employment problem. Unemployment rose from 3.6m in 1994 to 11.1m in 1997.

High unemployment combined with the impact of the Asian crisis on China - the stalling of export growth and foreign investment - prompted incoming Premier Zhu Rongji to launch a crusade for 8% growth.

This put a huge strain on an already overextended government statistics bureau to the point where one statistician wrote that it was 'not easy to maintain integrity'.

A Hong Kong newspaper in 1998 reported that the Shanghai government issued growth quotas to each level of its bureaucracy. If the quotas were not met, reports were sent back for amendment, the newspaper added.

Desperate to preserve their careers, Rawski says that officials fabricated figures.

He adds that between 1996 and 1999, China's GDP was officially reported to have grown by 25.6% despite a 12.2% reduction in energy consumption.

This defies economic logic. All economists accept that growth has to decline rather than rise when energy consumption, a basic indicator of GDP strength, is falling.

The China Daily wrote last year what could be interpreted as official recognition that between 1996-99, GDP growth actually slowed. 'The national economy is coming out of a slow period,' it said.

Rawski adds that another seemingly flawed official statistic is that farm output increased in all but one province in 1998 despite floods that rank among China's top 10 natural disasters of the twentieth century.

All that Asian petrochemical exporters can do at present is to hope that the first of the two economic opinions presented above proves correct. They cannot afford a dis-appointing year of Chinese demand growth given the poor state of petrochemical markets.

An indication of just how poor the markets are came earlier this month with the US$5-10/tonne fall in PE prices as a result mainly of large volumes of competitively priced imports from the Middle East (ACN 19 Mar, p29).

Few Chinese buyers were responding to offers as the impact of new capacities began to bite.

More new capacity will be added to that which recently came onstream in Taiwan and the Middle East.

The 800 000 tonne/year ExxonMobil cracker in Singapore and its downstream plants began phased commissioning earlier this month.

And the Optimal Olefins cracker and its derivative plants are due to start up in Malaysia later this year.

In styrene, a sharp drop in prices has forced several producers to cut operating rates.

The fall in prices is partly attributed to total inventory in eastern China which is estimated at 80 000 tonne.

Last year was a good year for Asia's polymer exporters to China. The country's total commodity polymer demand increased by 15%, say Japanese producers.

PVC was the fastest-growing polymer. Its demand grew by approximately 21% to 34.83m tonne while domestic production increased by 29%.

The hope this year and for the longer term for PVC is that the Chinese government's emphasis on private housing and the development of the western region, which includes improved distribution of power and water, will mean higher sales of PVC pipes.

'Many Asian exporters are forecasting that PVC demand growth will be much higher than that of GDP,' says a Japanese producer.

'But for 2001, we forecast PVC demand growth of 8% which is maybe a little conservative. We are not too optimistic.'

But the producer adds that domestic PVC consumption is increasing rapidly which will to a large extent compensate for any fall in demand from re-exporters.

In the case of PS, Chinese demand was last year estimated at 2m tonne which was 35% satisfied by local production. The forecast is for 4-5% demand growth in 2001.

However, because of new domestic PS plants, exports are not expected to rise dramatically.

HdPE was the best export performer of 2000, registering 26% growth.

The hdPE film-grade market displayed strong growth last year in China, both for re-exports and for the sale of finished goods into the domestic market. HdPE's lower prices when compared with those for ldPE resulted in increased substitution of hdPE for ldPE.

But the flip side of the coin is that growth in hdPE injection-moulding demand was slow because PP prices were lower in 2000 and remain much cheaper.

Import demand for hdPE injection-moulding grades is very poor because a large slice of what domestic demand exists is covered by local production, says a South Korean producer.

LldPE imports rose by 7% in 2000 and demand continues to be strong in the films sector. Processors are blending increasing quantities of lldPE with the more expensive ldPE. And for many more applications, 100% lldPE is being employed.

As for ldPE itself, the extrusion coating sector is performing particularly well. As lifestyles change, more and more Chinese in the wealthy eastern region are buying packaged food. The growth of multilayer packaging is supporting ldPE demand.

CMAI, assuming 7% GDP growth for 2001, forecasts that PE demand will increase for all grades by an average of 9.9% and PP by 10.5%.

The trends for polymer demand in China are good in the long term because of not only rising living standards and government investment in further developing the economy, but also trade liberalisation.

From 1 January this year, import tariffs on ethylene and PE were lowered to 0% and 16% from 5% and 18% respectively ahead of WTO membership. PP and PVC tariffs remained unchanged at 16%.

Further chemical tariff cuts are scheduled under the Sino-US agreeemnt (see p13). Polymer tariffs could be further reduced this year.

Also, quotas are expected to be removed from a few imported items each year under WTO regulations. PE imports are restricted by quotas.

But no matter how good the long-term prospects might be, the start to 2001 has been disappointing.

One South Korean producer, for instance, says that ldPE and lldPE demand rose by only 2-3% in January and February.

Overall Chinese polymer demand was worse than the industry had expected in January and February, after the impact of the Chinese New Year was discounted.

Just how much this supports the less sanguine argument for China's 2001 economic will become clear over the next quarter.

But the irony for polymer exporters is that even if China's GDP growth, real or official if the two are indeed different, does disappoint because of the US slowdown, export growth to China may still be healthy.

The lower that polymer prices fall the more rapid will be the substitution of plastics for conventional materials, says a South Korean producer.

This might be of little comfort to companies and their shareholders if money is being lost on virtually every tonne of polymer exported to China. In the new economic paradigm that is supposed to exist now that the Asian crisis is apparently over, pursuit of market share at the expense of profitability should not be the practice.

ACN doesn't own a crystal ball. If it did, the best way for it to make money would not be in magazine publishing.

What is certain is that given the global economic gloom and the problems confronting Asian petrochemical markets, more rests on China for the success of 2001 than for many, many years.

Production of major chemicals (m tonne/year)

	2000	Growth (%)
Ethylene	4.7	8.13
Propylene	4.26	17.92
Butadiene	0.59	10.52
PE	2.36	8.64
PP	2.37	14.79
PVC	2.39	29.38
Pure Benzene	1.84	11.49
Paraxylene	1.26	12.18
Styrene	0.76	27.61
Methanol	1.98	24.85
Phthalic anhydride	0.41	25.55
Soda ash	8.34	10.01
Caustic soda (100%)	6.67	15.42
Caprolactam	0.12	103.99
Monoethylene glycol	0.90	5.96
Polyester	2.21	28.92

Source: China Chemical Reporter

Capacity growth rates in China (%)

	2000	2001
HdPE	3.1	1.5
LldPE	12.4	1.8
LdPE	0.1	6.4
PP	1.9%	0.6

Source: CMAI

China polymer imports by country ('000 tonne)*

	1998	1999	2000
LdPE / lldPE
South Korea	673	435	331
Saudi Arabia	218	193	248
Japan	167	195	165
Singapore	146	110	110
Others	607	703	899
Total	1811	1637	1753
HdPE
South Korea	314	437	484
Japan	87	154	144
Singapore	52	70	101
Taiwan	18	44	120
Others	179	257	365
Total	650	962	1214
PP
South Korea	777	607	614
Japan	190	230	185
Singapore	133	106	140
Taiwan	118	139	193
Thailand	99	131	167
USA	68	90	118
Others	159	175	224
Total	1544	1473	1640

Source: Japan Polychem * estimates

Imports of major chemicals in 2000 ('000 tonne)*

Ethylene	89
Propylene	169
LdPE / lldPE	1753
HdPE	1214
PP	1640
PVC	1445
PS / EPS	2140
ABS	1470
Benzene	75
Toluene	573
Orthoxylene	76
Paraxylene	201
Styrene	1157
Phenol	97
Phthalic anhydride	217
Methanol	1307
Monoethylene glycol	1050
Purified terephthalic acid	2505

Source: Statistical Dept of Customs * estimates

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