Market outlook: China growth declines on economic rebalancing

13 May 2013 00:00  [Source: ICB]

When is lower growth good news for the chemicals industry in the long run? Perhaps in the case of China, if its economy is successfully rebalanced to a more sustainable growth model.

But several chemicals traders and producers that we spoke to were more worried about the here and now. They complained about the depressed state of China's chemicals markets in general, as they have done for most of this year.

Chinese building work Getty Images

Getty Images

Government may rethink massive spending on construction and infrastructure projects

Weak demand in China helps to explain why northeast Asian ethylene variable cost margins have been performing far worse than those in the US and northwest Europe.

The traders and producers hope that by the second half of this year, Beijing will have been tempted to relax economic reform through the launch of another big economic stimulus programme.

"OK, rebalancing is important, but so is growth," said a Singapore-based polyolefins trader. Perhaps they should be careful about what they wish for.

Another big stimulus programme, which seems very unlikely at the moment, would have to take the form of more infrastructure spending and a relaxation of lending restrictions.

This would likely worsen a bad-debt problem that prompted Fitch Ratings to cut China's sovereign credit rate to A+ AA- on 9 April. This was the first time that an international ratings agency had cut China's sovereign rating since 1999.

And then on 16 April, Moody's Investors Service affirmed China's government's bond rating of Aa3, but cut its outlook to stable from positive.

"Many analysts think that the apparent strong state of health among Chinese banks may just be an illusion," warned Standard & Poor's Ratings Service in a 19 April report.

"Some suspect that banks have not been reporting NPLs [non-performing loans] accurately. As evidence, they pointed to the much faster gains in loans classified as 'special mention.' These are loans that show higher risk characteristics but have not yet met the definition of NPLs.

"Others believe that the low reported NPLs reflect banks rolling over loans of borrowers who have trouble repaying. In either case, it is a matter of time before the Chinese banks have to face the cost of the surge in lending that they had allowed."

THE ART OF THE POSSIBLE

Politics in China might end up being the art of the possible, as is the case in so many other countries.

Relaxing lending conditions could further inflate the property bubble and so add to the resentment already being felt over real-estate prices. The cost of homes in China's major cities is out of reach for millions of people, argue several economists.

"I had to get an apartment first, which cost a lot of money, but luckily my parents were able to help me, and then I found a bride. There was no way I could have got married without an apartment," said a Beijing resident in his early 20s.

Then there is anger over the environment. Massive spending on low-value manufacturing, infrastructure and real estate - the old growth model - is said to be a major cause of air and water pollution.

The most internationally visible example of air pollution was smog levels in Beijing which in January were 40 times above the World Health Organisation maximum safe limit.

"I worry about my daughter, who is only one year old. I am really worried about the air quality and about food safety, and really hope that the new government can do something to make it worth staying in China," added the Beijing resident.

Efforts to clean up the environment are obviously bad for growth in the short term. Not only is finance harder to come by for new industrial investments, but there are also reports of heavily-polluting factories being closed down.

But reversing these initiatives could lead to economically disruptive levels of social unrest and more of the "brain drain" described by the Beijinger quoted above. China needs to attract and retain its educated middle classes, and a sufficient number of expatriates, if it is to avoid the "middle income trap" that we have discussed before in this column.

THE IMPACT ON GDP

Further aspects of economic reform are a crackdown on corruption and a frugality campaign, which is forcing government officials to display their wealth less ostentatiously.

Both measures are also depressing growth in the short term through fewer sales of luxury items such as handbags, watches, and cars.

But once again, reversing these reforms carries a risk.

A Shanghai resident in his early 30s who also has a young daughter said: "Even if you work very hard, and you take all the qualifications needed to get ahead, such as a good first degree and a good masters degree, if you are unlucky you still might not get ahead. It's all about connections to the right type of people."

The "right type of people" he was referring to are local and central government officials who are said to have gained more than their fair share of the benefits from China's economic boom.

The big question is the extent of the immediate impact on GDP of all this rebalancing. The evidence is not good.

On 15 April, China announced that the country's GDP grew by 7.7% in the first quarter - lower than most analysts' expectations.

This immediately led to several downgrades of full-year GDP growth forecasts.

global ethylene

For example, JP Morgan cut its growth forecast to 7.8% from 8.2%, while the World Bank trimmed its 2013 estimate to 8.3% from 8.4%.

However, in a 24 April report, Nomura said that there was a one in three chance of real GDP growth averaging only 5% or lower year on year over four consecutive quarters before the end of 2014.

The bank added in the same report that its China Stress Index, which monitors the risk of a hard landing, recorded its highest reading since it was launched November 2011.

Evidence from the manufacturing sector indicates weaker underlying economic conditions.

The HSBC Purchasing Managers' Index HSBC PMI Index for April fell to 50.5 in April from 51.6 in March.

A further cause for worry is that the external demand environment also seems to be weakening, as the HSBC PMI sub-index measuring new export orders dropped to 48.6 in April from 50.5 in March.

"New export orders contracted after a temporary rebound in March, suggesting external demand for China's exporters remains weak," said HSBC's China chief economist Qu Hongbin.

China's electricity consumption, which is widely viewed as an accurate barometer of the real strength of economic activity, grew year on year by just 4% in Q1 2013 compared with 9% during the first quarter of 2012, said Paul Hodges in a 25 April post on his ICIS blog, Chemicals & The Economy.

At the heart of the problem is that China is too dependent on heavy investment in industrial capacity, infrastructure and real estate as routes to growth. Thus, fully replacing these sources of GDP expansion could take considerable time.

"The property market occupies a central position in the Chinese economy," wrote the European Central Bank (ECB) in China's Economic Growth and Rebalancing - a research paper released in February 2013.

"The construction and real estate sectors account for 15% of GDP and 25% of total investment respectively," added the ECB.

"The impact on real economic activity stems from the strong linkages between the real estate sector and other industries," it continued.

"Real estate developments directly affect related industries such as construction, steel, cement, furniture, etc.

"In this context, the challenge authorities are confronted with is how to curb prices and speculation activity without impairing real activity."

However, the question remains. Does China have a choice in tackling property-sector distortions and all of its other economic imbalances?


By: John Richardson
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