INSIGHT: China chems to benefit from local focus

01 September 2008 09:50  [Source: ICIS news]

By John Richardson

SINGAPORE (ICIS news)--Do you stare at your beer glass and view it as half full or half empty? Because whether you are an optimist or a pessimist might have a considerable influence over your opinion about chemicals demand in China after the Olympic Games.

Chemical buyers and traders taking short positions obviously have a strong interest in talking down markets. This might be behind some of the reports of high inventory levels and aggressive price cuts by Sinopec in an effort to trigger a demand recovery.

Despite the best efforts of Sinopec, the wait-and-see game appears to be continuing due to speculation over just how bad the post-Olympics hangover will be.

Polyolefins buyers have the added incentive of keeping purchases to a minimum in anticipation of the big slew of new capacity due on stream in the Middle East from the third quarter of this year onwards.

But it would only take a few project delays for the buyers to suddenly find themselves in a lot weaker position and to extend reasonable profitability for well-integrated polyolefins producers into the second half of next year.

In Saudi Arabia in high-density polyethylene (HDPE) alone, for example, 1.5m tonnes/year of capacity is due to start-up in the third and fourth quarters.

Tight project-equipment markets and the usual problems with commissioning big complexes mean there is a big chance that a lot of this volume will only hit the market in 2009.

It’s also crucial to separate all the speculation and the hype surrounding the Olympics from the macro-economic reality.

Equally important is to not get too carried away by the temporary impact of high inventory levels, the inevitable result of overstocking ahead of the Games and a decline in electricity and gasoline demand post-Olympics.

“Total Olympic related spending over the past six years was $42bn,” says Arthur Kroeber of the China Economic Quarterly in his report, Please Calm Down: Post-Olympic Growth and Fiscal Stimulus.

"This was a massive sum to be sure, but only approximately 0.5% spent on fixed asset investment in China during the same period."

Kroeber adds that a lot of Olympic-inspired infrastructure projects will continue to deliver economic benefits for several years.

For instance, Beijing completed only four subway lines ahead of the event with a further 14 planned for construction over the next decade.

The overall economy might be slowing down as a result of weaker export growth, but a boom in domestic demand will offer short and long-term compensation, says Kroeber.

HSBC figures support a big short-term boost. Growth in retail sales volume exceeded 20% during the first eight months of this year, says the bank in its latest China Economic Spotlight report released earlier this week.

This represents the biggest rise in retail sales in a decade and will help sustain GDP at 9.5 per cent for the rest of the year, adds HSBC.

But the pessimists argue that the US slowdown - which could last several years and might trigger a global recession - is a big deal for China’s economy.

The textile industry in particular has been badly hit by a slowdown in orders from the West, and an estimated 40% of the GDP of Guangdong province is dependent on export trade as a whole.

Everybody agrees that growth is slowing - to around 9% this year and in 2009 from more than 11% over the last two years.

But Kroeber’s view is that this represents a welcome slowdown, reducing the overheating that’s long been a threat for the Chinese economy.

And he believes that there has been a policy shift from investment-led to consumer-led growth.

This will mean tighter monetary policy leading to a higher cost of capital. More expensive borrowing will compound the difficulties project planners are already confronting as a result of more stringent environmental legislation.

The government’s 2008 target for the growth in total loans was recently raised slightly to 14.5%. But this is still much less than the average 16.3% over the previous few years.

“Looser fiscal policy will balance this out (tighter loan conditions) by supporting government social services and household spending,” writes Kroeber.

How you view this looser fiscal policy again depends whether you view your glass as half full or half empty.

There has been a lot of media talk, and gossip among chemical traders, producers and buyers, about a big fiscal stimulus package in the second half that will rescue the economy from a sharp decline.

Expected measures include further increases in export-tax rebates that were reduced in June last year across a whole range of products. The rebates were raised on textiles and garments to 13% from 11% on 1 August.

The cuts have made importing chemicals for re-export as finished goods a lot less viable.

Money could also be spent on other tax cuts, on boosting the housing market and on reconstruction following the Sichuan earthquake. As much as $60bn could be injected into the economy, say press reports.

“Government revenues grew by 33% year on year in H1 2008,” Kroeber argues.

"China is heading for a budget surplus of 2% of GDP and so not spending this surplus would amount to a fiscal contraction. Spending some of it, which is what we expect will happen, makes good policy sense."

In other words, a big stimulus package would represent sound economics rather than a desperate rescue bid for stricken industries.

Such a package would trigger an increase in chemicals demand, particularly for polyvinyl chloride (PVC), formaldehyde and other chemicals used in construction.

GDP growth of 9% for 2008 and next year would also still be pretty awesome by the standards of most other countries.

Once the furore over the Olympics has finally died down, it looks likely that the Chinese economy will continue to deliver a huge boost to the chemicals industry - regardless of what happens in the stock market.

The local stock market has always been highly speculative and the recent collapse further supports the argument that it is, according to Kroeber, “a Neverland with no connection to the real economy”.

Strong fundamentals include urbanisation which is expected to continue to increase at a rate of 15m people a year.

But as the economy continues to shift to a consumer from an export-led growth model, the $64,000 question remains: How much of this growth will be captured by overseas suppliers and how much by local production?

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