INSIGHT: China's curious path to economic recovery

24 March 2009 17:40  [Source: ICIS news]

By John Richardson

LONDON (ICIS news)--The financial sector has indulged in an Alice in Wonderland game of economic nonsense that has wrecked the world economy. What’s happening in China also has the feel of the classic children’s book, although nobody will complain if the end-result is economic recovery.

“Banks in China are not too concerned if money is less or more as long as the enterprises go on operating and jobs for the common men are kept,” said a source from Zong Heng group, a major polyester producer in the city of Shaoxing, in Zhejiang province, in an ICIS news story on 23 March.

In the polyester and many other industries, money seems to be flowing to companies producing goods that might be going into inventories.

“In Shaoxing, the government has set out three ‘No’s’ for the local banks to avoid,” writes Tom Orlick, a Shanghai-based freelance journalist, in the online research publication, the China Economic Quarterly (CEQ).

These are no calling in of existing loans; no increase of collateral requirements on loans; and no imposition of additional requirements for companies wanting to take out new loans, he adds.

One beneficiary of local government support was troubled purified terephthalic acid (PTA) producer Hualian Sunshine Petrochemical, which received a reported yuan (CNY) 1.5bn ($220m) in aid.

Polyester producers are pledging to maintain operating rates of 75-80% in April and May. But just where is all their output going? 

China’s overall exports fell by 25.7% in February over the same month in 2008 with textiles, toys and electronics the worst-affected sectors.

“You have visions of row after row of warehouses packed with garments, with plastic toys and with computers as China waits for a global economic recovery,” says one perplexed plastics converter.

JP Morgan Chase Asset Management, in its Ins and Outs newsletter of 16 March, highlights the danger of this waiting game.

“China is building spare capacity in order to maintain economic activity in the short-term while positioning itself for future growth.

“But if such timely growth in demand does not materialise, these policies are likely to feed a traditional supply-induced deflation.

“If such a deflationary dynamic does indeed materialise its effects are likely to be exported since China is a major provider of goods and services to the rest of the world. Other exporters may respond by competitively lowering their prices.”

This could lead to increased pressure on debtor nations as deflation would increase the burden of their foreign debt, raising the likelihood of a classic liquidity trap, the bank warns.

The continued rally in petrochemical pricing – when indications a few weeks ago were that prices would – is now starting to make sense.

If this “spare capacity” is exported by China, petrochemical pricing can only, surely, head in one direction.

Naphtha is unlikely to offer much support in the second half as supply of feedstock looks set to lengthen substantially. (More details will be provided in a later Insight article.)

A big reason why chemical and polymer prices rallied from mid-January onwards was the recovery in naphtha, as refiners made operating rate adjustments, argue several sources.

Modest restocking by end-users also appears to have been a factor as does, rather worryingly, speculation by traders in China who were able to borrow money very easily from local banks. How much of this material is also stuck in inventories?

The good news is that a lot of the new Middle East capacity due on stream this year seems to be slipping into the fourth quarter and possibly even into next year. But new start-ups in China in the second half need also to be closely watched.

Another factor behind the price rally seems to be widespread production discipline by petrochemical producers.

“To a certain degree it’s also been down to extensive refinery turnarounds in northeast Asia that’s limited naphtha supply and the output from reformers,” says an industry consultant. “The turnarounds are due to come to an end in June.”

Let’s hope that all these imagined or real rows of warehouses stuffed with of everything from shirts to toys to shoes to keyboards will be emptied by strong domestic demand.

China’s CNY4,000bn economic stimulus package and $123bn for creating a basic healthcare insurance system should boost the sale of finished goods.

But as many as 30m migrant workers have lost their jobs due to the collapse in export trade. Some of these workers might end up re-employed on government construction projects, which make up the bulk of the stimulus package.

But will they spend their new earnings if they are worried about finding work once the construction projects are over?

Many of these workers are also likely to be earning less than $5,000 a year, as does 90% of China’s population.

Incomes below this level mean that spending is concentrated on basic necessities rather than consumer luxuries, or relative luxuries such as washing machines and TVs.

As in the US, consumer spending in China is being held back by lack of a universal health insurance scheme.

The government’s pledge to spend the $123bn on such a scheme amounts to, according to one estimate, only $14.40 per person per year.

China has “room to do more” to improve health, education and social security, says the World Bank in its latest quarterly report on China.

Perhaps more announcements will follow, and, as the World Bank also points out, the huge stimulus package is already showing signs of bringing stability to the Chinese economy.

GDP (gross domestic product) growth forecasts keep being revised down, however.

China’s economy will expand by only 6.5% in 2009, says the World Bank. This compares with its previous estimate – made in November last year – of 7.5%.

Professor Nouriel Roubini, the economist, warns that the country’s GDP could grow by as a little as 5%.

Let’s be optimistic and assume the Chinese government gets to its target of 8% growth for 2009. What would this mean for the global chemicals industry?

“Over the next few years Chinese demand is likely to be almost irrelevant because it will be overwhelmed by the collapse in demand everywhere else,” writes the CEQ in another article.

“Furthermore, since prices are a function of both supply and demand and, the large increases in supply brought on in recent years to cater to Chinese demand are now weighing down prices.”

China will only emerge as the key driver of demand and pricing when excess capacity has been absorbed, warn the authors.

It is really hard to be an optimist these days when every piece of evidence points to a very difficult economic environment for at least the next one to two years – very probably a great deal longer.

($1 = CNY6.83)

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By: John Richardson
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