China PVC outlook uncertain as housing troubles continue

23 August 2012 12:26  [Source: ICB]

It was obvious to many polyvinyl chloride (PVC) producers and traders that there was something badly wrong with China's economy when demand in 2009-2010 grew at more than double what they viewed as the normal rate.

"Around 1m tonnes of demand growth in a year is what I would describe as sustainable," says a source with an Asian producer. "What happened in 2009-2010 was clearly exceptional, but many of us were too busy making money to worry too hard about the longer term."

Data from Global Trade Information Services (GTIS) show that demand for the polymer surged from 10.9m tonnes in 2009 to 13.2m tonnes in 2010.

Demand then reached 14.1m tonnes in 2011. The slowdown reflected government efforts to deal with the after-effects of a huge economic stimulus package, which was introduced in late 2008 to combat the global economic crisis. Interest rates were raised and the availability of bank lending was reduced in an attempt to bring inflation under control.

And crucially for PVC in China, a large percentage of which is consumed in the construction sector, the central government imposed restrictions on the number of properties people could buy in around 40 cities and raised minimum down payments for homes.

The reason was that the cost of private housing, thanks to a speculative boom fueled by the stimulus package, had risen beyond the reach of the vast majority of China's population.

In December 2012, for example, real estate analysts quoted by the Financial Times estimated that the house price-to-income ratio in China's Tier 1 cities, including cities such as Beijing and Shanghai, had reached 14:1.

REAL ESTATE PRICES TUMBLE

The ratio was 10:1 in Tier 2 cities, and 8:1 even in Tier 3 cities. These are smaller cities with lower per capita incomes.

By comparison, the US ratio at the peak of its housing boom was only 5:1.

"The key is the country's relative poverty," wrote Paul Hodges, chairman of UK-based consultancy International eChem, in a January 23 post on his ICIS Chemicals & the Economy Blog, commenting on the FT article. "It is only 90th in the world in terms of GDP/capita at just $5,184 (€4,192). This is a long way from the US at $48,147 or Germany at $44,558," added Hodges.

Real estate prices have declined since January, falling by as much as 14% in May alone in the city of Wenzhou (a Tier 2 city) in Zhejiang province, according to China's National Bureau of Statistics (NBS).

Prices in most major cities fell during the first half of 2012, resulting in a 16.3 percentage point year-on-year decline in real estate investment, says the NBS.

"A weaker property sector is one of the major reasons why PVC demand was either flat, or possibly even in minus territory during the first half of this year," says the source with the Asia producer. "Local carbide-based plants have been running at operating rates of below 60%."

And because real estate accounts for around 10% of overall GDP, according to an official government estimate, the sector's slowdown is clearly bad news for chemical and polymers demand in general.

What are the hopes for a property sector recovery in the second half of the year?

FEARS OVER A "DEAD CAT BOUNCE"

The prices of private homes rose by 0.3% in June, the largest increase since the same month last year, according to SouFun Holdings, China's largest real estate website operator. "It is very clear that China's property market is coming back," Vincent Mo, chairman of SouFun, said in a Bloomberg TV interview on August 1, adding that the market had reached a turning point.

But it depends how you define a turning point. Prices might have temporarily bottomed out, but Beijing has repeatedly made it clear that it will not relent on the clampdown of the property sector.

China's Premier, Wen Jiabao, for example, was widely quoted in state-run media as saying in a July 26 speech that real estate sector controls would be "unswervingly implemented" to prevent home prices from rebounding.

And in late July, eight government teams were sent to 16 provinces to check on the implementation of property curbs, according to a statement on a central government website.

The reason is that, despite the price falls, real estate remains unaffordable. In June, for example, apartments in Wenzhou cost an average of yuan (CNY) 3,000/m3 ($3,950/sq yard), equal to the average annual per capita disposable income, according to a June 19 ICIS Chemicals & the Economy Blog post.

Tackling such huge economic disparities is viewed as a priority, given that China is about to undergo its once-in-a-decade leadership transition. From October 2012, senior politburo leaders are due to be replaced, including China's premier and president.

"The last thing that Beijing wants right now, ahead of the new leadership settling in, is an increase in social unrest before the transition," says a senior Asia-based executive with a global polyolefins producer. "Another surge in property prices could trigger more unrest from people who have already been priced out of the private homes market."

Patrick Chovanec, a professor at Tsinghua University's School of Economics and ­Management in Beijing, also takes issue with the notion that real estate has reached a turning point.

"There is genuine growth in demand for housing - as well as office and commercial space - in China, but there is also evidence that both developers and investors have gotten ahead of the market," wrote Chovanec in a July 31 post on his blog, An American Perspective From China.

"Developers have built up large stocks of unsold inventories that they are now under great pressure to liquidate in order to pay mounting debts," he added.

Over the past two years, developers have accumulated very large inventories averaging one to two years' worth of sales, he said. "We know that they have heavily leveraged themselves, by a ratio of at least 70%, in order to carry these inventories."

And as credit availability has been reduced, the interest rates many developers have been forced to pay to the shadow banking system (private, non-state-owned lenders including trusts and wealth management companies) had risen, often into double digits, he added.

"We also know that many of these debts will come due in the second half of this year," said Chovanec.

This year, $35bn of trust loans are due to mature, almost half of which reach maturity between July and September, added Chovanec, quoting data from securities brokerage China International Capital. This suggests that developers are under considerable pressure to talk up the market in an attempt to boost sales volumes.

Chovanec gave other reasons why he believes the real estate market may not have reached a turning point.

"The capacity and willingness of Chinese investors to front for future demand may be reaching its limits," he said. "All of this raises the real possibility that people who are buying into the latest rally, in the belief that prices can't fall any further, may be misjudging the market, and the rebound we are seeing may be a classic 'dead cat bounce.'"

A telling statistic from the same blog post, underlining Chovanec's point about the future capacity of investors, is that Chinese households own an average of 1.2 homes.

This implies that "one-third of all home-owning Chinese have invested in a second property," he added.

By: John Richardson
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