Surprise China rate hike should slow chemical investments

29 October 2004 06:02  [Source: ICIS news]

SINGAPORE (CNI)--China’s unexpected increase of its benchmark interest rates should curb the country’s rapid domestic demand growth, and may have a knock-on effect on new investment in the chemicals industry, analysts told CNI on Friday.

 

The People Bank of China on Thursday raised its benchmark interest rates by 0.27 percentage point, to 5.58% for one-year lending and 2.5% for deposits. The rate increase, the first in nine years, was the latest step and possibly the most serious step that the country has taken to stop its economy from overheating.

 

Although the country had tightened bank lending and introduced other quantitative monetary policy measures, the authorities had so far resisted raising interest rates as the move could have very broad implications. “They didn’t do it before because it is a very serious measure. It will affect the foreign exchange rate, property markets and investment,” said Don Tao, the main China analyst with Credit Suisse First Boston (CSFB) in Hong Kong.

 

Global commodity and crude prices have dropped with the move and on concerns that it would be followed by further rate hikes. After falling earlier in the week on bearish US supply data, the Nymex December crude dropped to an intra-day low of $50.78/bbl on Thursday, while the IPE Brent December crude bottomed out at $48.30/bbl before rebounding slightly. There were similar declines in the prices of copper, steel and other metals.

 

 “This is the first step in what will be a long process of monetary tightening,” Tao said. He expects further rate increases, which would come to a cumulative two to three percentage points (200-300 basis points) over the next 12-18 months.

 

Tao believes that the interest rate increase, combined with other measures and the expected further rate hikes, will likely reduce China’s gross domestic product (GDP) growth to 6.5% next year from an expected 9.3% in 2004.

 

For the chemicals industry, Tao says there shouldn’t be much of a drop in China’s consumption. However, he said that he expected a decline in new investments.

 

Dave Witte, vice president and managing director of chemical industry consultancy CMAI in Singapore, agreed that the slowing economic growth would have a minimal impact on prices.  “As long as we have growth, there’s still not going to be much impact on the demand side,” he said.

 

While China’s olefins market may be coming more into balance next year, the aromatics market would remain very tight, he said. That, and not the crude prices, has been driving the current bullish prices for the chemicals market.

 

And while a two to three percentage point hike in borrowing rates would interrupt or deter new investment by smaller players operating small to medium-scale projects, such as derivative polymer operations, Witte does not see it as having a major impact on large-scale projects.

 

Large projects are generally headed by major Western producers and China’s state-owned majors, such as Sinopec or PetroChina, so a rate rise would not have much impact on their abilities to raise funds. However, “for smaller players who are more cash strapped, this could make a bit more of a difference, and it will probably slow investment in downstream areas,” he said.

 

Earlier this year China had used a series of administrative measures to stem growth, including tighter guidelines for lending to the real estate sector and steps to remove liquidity from the system.

 

It also took steps to curb investment in the chemicals industry. It said that projects that fell below specified capacities or which employed  technologies viewed as environmentally damaging would be subject to a review that could lead to them being scrapped.

By: Chris Myrick
+44 208 652 3214

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