16 February 2010 12:19 [Source: ICB]
Overexcitement about the upside or downside for the consumer market in China is a dangerous thing
UNDERSTANDING CHINA is a mammoth task. And so to make a firm claim that demand for consumer goods will either continue to grow at the high rates seen in 2009 or suffer a cataclysmic short-term collapse is extremely risky.
"We deliver a growth number to our customers on any product with the caveat: 'This is the best you are going to get, but it could still be wrong to a significantly high degree.' It's all about trying to at least hit the dartboard. Anywhere close to the bull's eye is impossible," says a Beijing-based consumer products consultant with many years of experience tracking the market.
There are numerous factors that will affect growth in consumer goods over the next few years, and thereby also chemicals and polymers. The easiest way to split this is to start with the pessimists, followed by the optimists, before attempting to conclude with a touch of balanced realism.
THE BUBBLE THEORY
Bank lending in China during the first two weeks of January soared to record-high levels, surpassing on an annualized basis the big rise in loans for the whole of 2009, according to media reports.
Lending jumped by 39% in 2009, according to an estimate by online economics research publication China Economic Quarterly (CEQ), published by China-based consultancy Dragonomics.
Not surprisingly, inflation is becoming a threat. The official Consumer Price Index rose by 1.9% in December year on year, with estimates for the increase in the February CPI (the actual January data was not available as of press time) as high as 3%.
But headline inflation rates do not reflect a seemingly alarming real-estate bubble.
"The average real-estate price in Beijing is Yuan 20,000 ($2,930)/square meter. That is a 30% increase in one year. Shenzhen [in southern China] has seen a 90% increase in house prices," says a Beijing-based chemical consultant. "If you look at salaries, a fresh graduate gets Rmb2,000-3,000 ($290-440)/month. This is causing a social problem."
A Shanghai-based US citizen adds: "It doesn't feel right - it feels like a bubble economy. With property so expensive here, average salaries are still only a quarter of US levels in major wealthy cities such as Shanghai, and even less elsewhere as you move inland."
And while much is made of the fact that the average price of an auto is only $17,000 (€12,500) in China, compared with $30,000 in the US, "direct comparisons are not valuable because very cheap local cars - some of which might come with brakes as an optional extra - drag the average price down. Foreign-branded autos in China cost 50% more than in the US."
Gasoline prices were also about $3.71/gal (as of January) versus about $2.50 in the US, he notes. "This place is getting expensive."
Also driving inflation is a long-term tightening in the labor market because of a shift in demographics, according to the CEQ.
During 1998-2003, thousands of workers laid off from state-owned enterprises (SOEs) undergoing restructuring had to be absorbed, creating deflationary pressure, according to the December 2009 issue of the CEQ. But since then, there has been an "increasing tendency of monetary growth to generate inflation" because the workforce entry population is in decline.
This reflects anecdotal indications of a rapid re-tightening of labor markets in 2009 in China's key manufacturing regions.
"After millions of migrant workers were laid off in 2008, we saw manufacturing activity rise very sharply in Guangdong province during 2009. Labor costs went up," says a Singapore-based source with a global polyolefins producer, reflecting what is also being said by other polyolefins producers and plastic processors.
TIGHTENING MONETARY POLICY
And so late January and early February saw a flurry of monetary tightening measures. These included two increases in intra-bank lending rates in the space of a week, a ban on further lending by some banks from mid-January to the end of the month, and a rise in the reserve requirement for all banks.
The Bank of China has reduced discounts on mortgage rates, and banks in general have reportedly assigned much more stringent lending targets for this year.
"This could take some of the froth out of consumer spending," adds the source at the polyolefins producer.
The scale of the potential "froth" looks quite scary. Total vehicle sales jumped from 9.4m in 2008 to 13.8m in 2009, according to global consultancy Frost & Sullivan (see graph on page 24) and the China Association of Automobile Manufacturers.
Much has been made of how this total has for the first time surpassed that of the US - where 10.4m vehicles were sold last year.
"The first quarter of 2010 will follow the strong momentum of 2009 [for auto sales]. However, the pace of growth will slow down," says the latest China Automotive Climate Index, released in late January.
The survey, produced by China's National Bureau of Statistics and Beijing-based consultancy Sinotrust, warned of excessive production and inventories among producers.
The importance of the housing sector in boosting demand for everything from autos to plastic utensils for equipping kitchens is huge.
"It's the wealth effect. As property values have increased, spending looks as if it's risen across the board," says the Shanghai source.
Estimates of growth in 2009 for furniture, building and decoration materials are 25%.
But it was a sharp drop in property prices and construction activity from late 2007 that caused China's last economic downturn. The government took economic cooling measures in September of that year, which in hindsight proved to be excessive.
The danger is that the mistake will be repeated over the next few months, as Beijing tries to gently ease inflationary pressures.
The long-term growth potential in consumer goods for the Chinese market is undoubtedly tremendous. Consumer goods consumption is concentrated in China's eastern and southern provinces, with enormous untapped growth potential inland to the west.
But China needs to improve capital efficiency (a lot of wasteful lending goes to SOEs) and reform "fragmented and distorted" domestic markets (the cost of logistics is very high), according to the CEQ.
The financial system also needs to be restructured, the publication adds. "Bank deposits are very low with an underdeveloped financial products market. As a result, investors have little choice but to gamble in property and other risky assets, exacerbating asset-price bubbles when liquidity is loose," says the Shanghai source.
Higher dividend payments and broader financial sector liberalization are needed, according to Michael Pettis, a former Wall Street trader and professor at Peking University's Guanghua School of Management, on his China Financial Markets blog. Straightforward assumptions of incomes rising in a steady and even progression ever-westward are also flawed because of the distribution of consumers, according to the CEQ.
It pointed out that Chinese households with annual expenditures of less than $5,000 - about 90% of the population - spend most of their money on housing, food and clothing.
Those with income levels high enough to be able to spend more than $5,000/year, the so-called "consumption households," mainly live in three regions - the Yangtze River Delta, the Pearl River Delta and the Beijing-Tianjin corridor. Each of these regions surrounds mega-cities, whereas other consumption households are more thinly scattered across the rest of China.
"Although there are a growing number of these households dispersed across the rest of the country, they are not concentrated enough to justify a sales and distribution presence for many products and services," notes the CEQ. "Research by [US-based credit card firm] MasterCard suggests that multinational consumer-goods companies require a concentration of at least 20,000 consumption households to establish a viable market."
To summarize the counter-arguments from the optimists, they believe that the government has a pretty solid record in managing the economy - and certainly a great deal better than many Western governments.
China should be able to learn from its mistakes in late 2007 and cool the economy down without causing a severe correction. An indication of this competence was how "strong, decisive and deftly timed stimulus policies at the start of the financial crisis played a major role in China's quick (economic) rebound," wrote Fan Gang, professor of economics at Beijing University and the Chinese Academy of Social Sciences, in a February 2 article in the China Daily newspaper.
Another argument is that huge infrastructure investments might seem excessive in the short term, but China is not building "bridges to nowhere," as was the case in Japan in the 1990s and into this century. Hundreds of thousands of kilometers of new roads and rail track, together with world-class ports and airports, are preventing the kind of bottlenecks that can hold back future consumption, some economists argue. They cite India as an example of a country where poor infrastructure investment has held back poverty alleviation.
THE EMPTY CITY
You may have seen the now-famous YouTube video of Ordos from the Al-Jazeera TV news channel.
Ordos, a city in Inner Mongolia, seems to represent many of the short-term downsides and long-term upsides of huge infrastructure spending.
"Yes, buildings might stand empty for a while and bridges and ports may be underutilized, but China is not going to go bust like Dubai almost did, as its government has huge reserves and a long-term vision," says a Singapore-based source with a polyolefins producer.
China might suffer more volatility on asset price bubbles, but relative to the West, growth prospects are staggering. The China Economic Quarterly, for example, sees sustainable GDP growth at 8%/year over the next few years.
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