12 July 2013 09:38 [Source: ICB]
After a stronger end to the second quarter, the outlook for Q3 is less sanguine in light of high borrowing rates and less available credit. Do not count on China as the world's growth engine
June was a good month for Asia's polyethylene (PE) industry. Both volumes and margins improved as a result of a reported delay to the start-up of a big new complex that left end-users short of inventory. But the story is likely to change in the third quarter as China's economic reforms start to bite.
"China's converters had held back for such a long time from buying because they expected substantial production to hit the market from the new ExxonMobil complex in Singapore sometime in May," said a source with a global polyethylene (PE) producer.
"It didn't happen, and, as a result, the market seemed very tight indeed in early June and fairly tight up until mid-June. We, as a result, managed to sell a month-and-half's worth of material in June."
How hard the complex operates will be a key determinant of the Asian supply and demand balance during the rest of this year.
There is less concern about Wuhan Petrochemical's two 300,000 tonne/year PE plants and a 400,000 tonnes/year PP unit, which are due on stream in Hubei Province, China, in mid-July.
"Percentage-wise, these capacities will not make that much of a difference to the overall balance," the source added.
A bigger concern is over demand in China which has been the case ever since April 2011, when sales and marketing executives at several polyolefin producers first flagged up that there was something amiss with the country's economy.
Another factor behind reports of a strong June for the PE producers - which enabled them to force through several weeks of price increases - seems to have been a mini-economic recovery.
"Construction activity is improving if what we saw in Qingdao is typical of a second tier city," said Simon Hunt, a UK-based copper industry and economics consultant, in his June 2013 China Visit Report.
"A year ago all activity on buildings, whether commercial or residential, had ground to a halt. Starting around September last year, we noticed a gradual improvement reaching the point that activity appeared to be normal when we were there a week ago."
But he added that money had since become very tight, thanks to the government's determination to deal with excess lending, which led to the late June credit squeeze.
In the tube and wire and cable industrial sectors, he said that there were reports of bankruptcies as part of a deliberate policy by Beijing to restructure all types of industries into "units that can compete internationally on product quality and price".
He dismissed the view of some analysts that China will relax its economic reforms.
"We think that the only easing will be to provide temporary help to the market to allow a more orderly pace of restructuring because China's dependence on credit has reached the point whereby its effectiveness has all but disappeared," he wrote, in the same June report.
He quoted Charlene Chu, senior director of financial institutions at Fitch Ratings, who estimates that the ratio of GDP growth generated by each remninbi (yuan) of new lending has dropped from 0.85 to just 0.15 over the last four years.
Meanwhile, total credit in China has grown from $9 trillion in 2008 to the current $23 trillion, according to Fitch.
"To place $23 trillion into perspective, it equates to the entire US commercial banking system," said Hunt, who runs Surrey-based Simon Hunt Strategic Services.
Thus, Hunt, along with many other commentators, believes that while China is hardly going to allow the entire financial system to collapse, it is determined to engineer a credit crisis significant enough to force weaker companies to the wall.
"Smaller banks and others engaged in the shadow-banking system may well fail too," said Hunt.
An Indian chemicals trader, who recently returned from a trip to China, added that borrowing rates were already very high, even before the recent credit scare. He said this was the result of a concerted government effort to deal with excess credit stretching back to February this year.
"While large enterprises still have access to bank credit, small and medium-sized enterprises have to borrow from non-banking channels [the shadow-banking system] and, as a result, have to pay interest rates of 15-20%," he said.
"Construction companies are unable to get hold of finance at anything less than 20-22%."
Businesses in general had become concerned about the second half of the year, added Hunt.
"Our discussions with a leading appliance maker indicate that consumer spending on durable goods will slow significantly," he said. Appliance makers are major consumers of polymers.
Meanwhile, the final China HSBC/Markit Purchasing Managers' Index (PMI) for June, which was released on 1 July, retreated to 48.2, the lowest level since September 2012 and down from May's final reading of 49.2.
An official government PMI, also released on 1 July, fell to 50.1 in June from 50.8 in May.
"We think that Q3 could be very volatile indeed and we remain concerned about the underlying strength of demand. The Chinese government isn't going to back down on the reform process and so we believe that GDP growth will be around 6% this year," said the source with the global PE producer.
ROUTE TO REFORM
"Xin Jinping and Li Keqiang [China's president and prime minister, respectively] are very strong leaders and so have decided that they can take the painful route to economic reform. Economic reform has to happen pretty quickly to avoid political reform - ie the collapse of the Communist Party - but I think it's still going to take 1-2 years for the reforms to work," he added.
There is a risk that the reforms will take even longer, assuming that they actually work at all.
This could result in a decade, or even longer, of GDP growth of as low as 3%, some economists, such as Michael Pettis, have been arguing for a long time.
Six months ago, the views of these economists were a huge distance from the consensus on China.
But now even some of the major investment banks, traditionally so bullish on China, have become quite bearish.
What seemed inconceivable to so many people six months ago has become conceivable - that China can no longer be the main driver of global economic growth, as long as restructuring remains incomplete.
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