China's economic boom may be coming to an end, impacting chemicals

Great while it lasted

30 April 2010 00:00  [Source: ICB]

China's staggering growth in chemical and plastics demand in 2009 will prove to be unsustainable. But can India's success story continue?

Rex Features/Chris Eyles

CHINA'S ROLE in supporting growth throughout the rest of Asia partly rests on the strength of its demand for basic raw materials such as iron ore, metals, coal and petroleum. Booming demand for all of these commodities has helped support strong economic recoveries in Australia and Indonesia.

And it is no exaggeration to say that China's demand for basic chemicals and plastics has been vital for the global industry in the face of much weaker demand in the West.

If you are high up the value chain, in the case of countries such as Japan or South Korea, it is the extent of China's demand for high-technology imports that matters most of all. In Korea's case also, though, around 50% of its commodity polymer exports go to China.

Nobody realistically expected that China's extraordinary 2009 chemicals demand growth would continue, along with its steep rise in imports, which hugely benefited the global industry at a time of weak Western demand (see graph).

Weaker growth is expected to occur as rising local capacities, especially in polyolefins, eat away at import volumes.

The imports that remain will increasingly be taken by highly competitive new Middle East production, where the object is to keep running at high operating rates, almost regardless of market conditions.

Expectations for 2010 have been trimmed back because, as Fred Peterson, president of US-based consultancy Probe Economics points out: "China was restocking in 2009 as the rest of the world destocked, and so that process had to come to an end."

China also introduced the biggest economic stimulus in world history in 2009, which greatly boosted demand for chemicals and plastics.

This comprised new bank lending amounting to one-third of the country's GDP, and an additional $586bn (€440bn) of government spending. Some fiscal and monetary tightening was therefore inevitable.

Largely because of China, global trade volume for all the major commodity polymers was higher than in 2007, according to International Trader Publications, the New York-based trade data and analysis service.

When you consider that demand was weak or even declining in the West - and that the developed world remains on a volume basis the largest market for these polymers - this illustrates the scale of the distortions created by China.

West European trade in the big commodity polymers (intra-regional plus imports) fell by between 3% and 18% in 2009, adds International Trader.

WHERE DO WE GO FROM HERE?
Demand-growth estimates from Shanghai-based commodity information service CBI point to steep falls for polyethylene (PE), polypropylene (PP) and purified terephthalic acid (PTA).

Overall PE growth is, for example, expected to fall to 8.6% in 2010, 7.7% in 2011 and 7.4% in 2012. Growth last year was a staggering 30.3%.

"Last year was exceptional. We expect growth in the future expanding more in line with GDP," says Longston Li, a member of the CBI polymers reporting team.

Other market analysts take a slightly more positive view, including Mazlan Razak, Kuala Lumpur Malaysia-based chemicals consultant with DeWitt & Company.

"The Chinese government is projecting, or rather trying to keep, GDP growth at about 8% in 2010. We think GDP is more likely to expand by 8-9%, he says. "And so with a multiplier over GDP of 1.2-1.5, we are looking at 9.6-13.5% growth for polymers."

This is a higher multiple than in 2000-2009, when, according to Razak, polymers growth in relation to GDP was virtually flat.

"The improved multiple is a result of increasing domestic consumption as people get wealthier and the economy becomes less export-focused," he says. Progression to a higher level of consumption depends on how well the government manages an economy that has shown signs of overheating.

"The government's dilemma is that it needs to deflate this [referring to the housing market] incipient unproductive asset-price bubble, but do so without causing the broader economy to stall out," writes the online Beijing-based research publication, The China Economic Quarterly.

"It faced this dilemma once before, in late 2007, and failed the policy test. Draconian property restrictions caused the market to collapse, leading over the next nine months to huge falls in construction volumes, demand for basic materials, and industrial production.

"Can Beijing do better this time? We hope so, but the proposition that the government can successfully micromanage the movements of the property market is entirely faith-based."

Real estate prices rose by as much as 90% in some cities such as Shenzhen in 2009. Strong increases continued into this year - for example, a 10.7% nationwide price increase in February.

Here are some of the other major factors behind China's extraordinary 2009 growth and an assessment of their long-term impact:

Government stimulus programs, including discounts on cars, and the vouchers program (vouchers that give money off purchases of washing machines, refrigerators and so on) in rural areas led to a big rise in consumption from late 2008. These programs are set to continue.

Filling inventories. A lot of the bank lending, especially the loans that went to the state-owned enterprises, was used for fixed-asset investment in new industrial capacity, says a UK-based chemical consultant. These factories needed chemicals and polymer raw materials to start operating, he adds. Inventories at many new factories will have been filled and so the issue now is how hard these plants will run, based on local and export demand, he says. Exports could be damaged if the value of the yuan rises versus the dollar. Financial analysts are predicting that the yuan will be allowed to appreciate slightly in the second half of this year, as the US and China look likely to reach a compromise deal.

No-risk speculation. Easy liquidity meant that traders could switch between different commodities in 2009, comfortable in the knowledge that lending terms were very easy, and that at some point in their complex multiple trades they would make money. The traders were also able to easily afford the risk of stockpiling chemicals and other commodities as a result of ample bank lending. China plans to reduce the volume of new loans it issues by 22% in 2010 compared with last year.

INDIA'S PROMISE REALIZED
India is a story in its own right that is worth attention. The country at long last seems to have abandoned its traditional dance: One step forward, two steps back.

Yet "India remains at least 10 years behind China in terms of consumption of basic chemicals and plastics," says a Singapore-based source with a US-headquartered commodity and specialty chemical producer.

"But we are now seeing much more consistent, much stronger growth in India. There is also a great deal more foreign investment in downstream and specialty chemicals, although upstream basic ­chemicals remain a tough proposition if you are a foreigner."

Rex Features/Chris Eyles

The country's long-standing potential of a high population and low per capita consumption of chemicals is finally being realized, he adds.

Major commodity polymers saw ­double-digit growth rates during April-December 2009, which has surprised many market participants.

Demand for polyvinyl chloride (PVC) rose by 30% to around 1.35m tonnes as a result of strong sales in the pipes segment, according to local industry estimates.

PP demand rose by nearly 29% to 1.6m tonnes and low density polyethylene (LDPE) was up by about 25% to 260,000 tonnes, the industry sources add.

Linear low density polyethylene (LLDPE) increased by 16% to 690,000 tonnes and high density polyethylene (HDPE) demand expanded by 13% to 980,000 tonnes, say the sources.

Greater foreign investment is taking place not only in specialty and downstream chemicals but also in manufacturing, adds the Singapore-based source with the US chemical player.

"The irony was that at the height of the economic crisis, India didn't suffer as much as China because it had failed to build as big a manufacturing base - and therefore didn't see as steep a fall in exports to the West," he says.

"This weaker manufacturing base was the result of poor infrastructure and restrictive labor practices, but this is changing."

South Korean auto major Hyundai has invested heavily in India to emerge as the country's largest car exporter, says an Indian polyolefins producer.

The Indian arm of Hyundai - which exports four models to 110 countries - said recently that its local exports grew by 10.7% last year, despite the global slowdown in the auto sector.

Government investment in new roads, ports and airports is expected to deliver a further boost to chemicals and plastics consumption.

But still, India is a small consumption market in global terms - and especially when measured against China. The result is that new capacity in certain chemicals and plastics is capable of pushing the market into oversupply for several years at a time.

Quote "Take away the export recovery and the domestic outlook remains very bleak" Tokyo-based UK expatriate

India's PP exports, for example, are expected to rise from 500,000 tonnes/year in April-December 2009 to a peak of 1.3m tonnes in the year ending March 31, 2011, according to one industry estimate. This is the result of new capacities by Reliance Industries and IndianOil.

Import opportunities for other commodities where the investment case is weaker remain strong, though, for instance in the case of PVC. High domestic power costs have deterred investments.

THE JAPANESE DILEMMA
Japan has benefited perhaps more than any other country from China's economic stimulus - leading to a very strong export recovery.

Global financial services firm J.P. Morgan recently improved its first-quarter GDP growth estimate, based on these strong exports, to 3.5% from 1.8%.

"Take away the export recovery and the domestic outlook remains very bleak indeed," says a Tokyo-based UK expatriate.

"In the longer term, Japan has to address rising government spending versus insufficient tax revenues and the constant threat from deflation."

In 1990, close to six people of working age supported each retiree, according to government data. This ratio is expected to fall to just two workers for every pensioner by 2025."The Bank of Japan should fight ­deflation through a strong commitment to keep interest rates at their very low current levels and to implement quantitative ­measures effectively until underlying inflation is firmly positive," writes the Organization for Economic Co-operation and Development (OECD) in its most recent report on the country.

"Additional fiscal stimulus is not warranted, given the expected pickup in output growth, as well as Japan's large budget deficit and high public debt ratio.

The government should thus finance its planned rise in public expenditure through cuts in other spending programs."

As the expatriate points out: "There is nothing new in what the OECD has to say, it's been said for several years now, but the question is whether these issues will be addressed."

Read Paul Hodges's Chemicals & the Economy blog

 

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