Market outlook: A growing sense of unease

26 July 2013 08:48  [Source: ICB]

Privately, in one-to-one meetings, senior executives at one particular chemicals company readily admit that China no longer offers any ­guarantees, said a source who works for the company.

"But the public message remains 'everything will be all right in the end. We can't provide you with a coherent argument as to why this will be, so just believe us,'" the source added.

Li Kequiang Rex Features

Rex Features 

China prime minister Li Kequiang is taking steps to restructure the economy

This is despite the highly risky economic, social and political changes being attempted in China, which we have covered before in this column. "I think nobody wants to publicly admit the truth, that it might go very badly wrong, because if you start building that into your scenarios, then your whole strategy needs to be changed," said the source.

"Assuming the worst about China is just too uncomfortable, too difficult, and, in terms of internal company politics, just too risky for your career." Strong words indeed, and they probably would not have been spoken - even deeply off the record - six months ago, when all seemed much better with China.

Now, though, there is a growing, almost palpable sense of unease about the short-, medium- and even long-term outlooks for a country that has powered global chemicals demand growth so far this century.


This unease is increasingly finding its way into macroeconomic analysis.

A good example is a June 2013 article posted on the McKinsey Quarterly website, authored by Yasheng Huang, professor of the Massachusetts Institute of Technology's (MIT) Sloan School of Management.

He talked of the March 2013 bankruptcy of Wuxi Suntech, the subsidiary of solar-panel producer Suntech Power, as illustrating much wider problems.

"The woes of Wuxi Suntech and its counterparts in other industries exemplify the massive policy challenges that will confront China's new leaders in the next decade," wrote Huang, who also founded and heads the China and India Labs at MIT.

"These challenges can be distilled into one statistic: household consumption accounts for only around 38% of China's GDP.

"To put the facts another way, consumers have not begun picking up the economy's slack, as they must if they are to fuel economic growth now that the country's investment-led model is reaching its limits.

"Chinese household consumption as a share of GDP is barely half that of the United States, where it typically accounts for about 70% of economic activity, and significantly less than the prevailing rate (approaching 60% in recent years) of other large economies, such as Brazil, France, Germany and India."

He added that Xi Jinping, China's recently appointed president, and its new prime minister, Li Keqiang, have taken tentative but encouraging steps towards overhauling economic growth. For example, the government has:

Released a plan to raise the dividend payments of state-owned enterprises (SOEs), a portion of which would be used to increase social-security payments. The plan still needs to be approved, but Huang said that there is now a realistic possibility that the investment appetite of the SOEs will be curbed as wealth shifts to Chinese households.

Proposed a carbon tax, which would be rolled out over the next two years. Although the tax will be modest, Huang argued that it indicates that Beijing is serious about tackling the country's environmental crisis.

Said it will remove or reduce energy-price subsidies. "Production subsidies stealthily transfer wealth from households to firms, reinforcing the production and capacity-building biases of the Chinese system and supporting less competitive companies, including many SOEs, that would otherwise struggle to invest and grow," he said.


This rebalancing requires Xi, Li and the rest of the Politburo to persuade the SOEs, and other large investment-oriented entities, to take an economic back seat to allow household wealth to grow, Huang added. He warned that they have to succeed, because the investment-heavy growth strategy has ­become both ­economically and environmentally unsustainable.

"China is rapidly reaching the point of diminishing economic and political returns from its investment-driven model, which is headed for change one way or another: either through a proactive rebalancing, with reforms and policy adjustments, or a forced rebalancing precipitated by rising stresses in and beyond the financial system," he said.

Paul Bjacek, the research lead for Accenture Chemicals and Natural Resources, agreed with Huang that investment has increased as a driver of China's GDP growth.

"Chinese private consumption as a share of GDP declined by 4 percentage points between 2000 and 2012, to a level of 39% in 2012, as compared to 71% for the US," he said in a May 2013 post on the Accenture Chemicals, Metals and Mining blog [see chart].

And he added that a shift in China's export competitiveness and its mix of exports represent challenges and opportunities for the chemicals business.

Chinese exports have been decelerating significantly, when China's trading-partner import data is analysed, he said.

"At that time, China was in or near the lowest cost position on the global labour-intensive finished goods manufacturing cost curve, forcing other regions to make the necessary factory shutdowns," he wrote.

"This has now changed and represents a significant development for materials suppliers to China."

China Exports

For most of the past decade and a half, China has been the centre of focus for world growth in demand for basic materials, including chemicals, minerals and metals, Bjacek continued. But the problem was that China's growing manufacturing activity tightened labour supply, thus driving up wage costs. China's one-child policy has also brought to an end the demographic dividend it enjoyed from an abundant and therefore cheap supply of workers. Other competitive factors have also come into play, resulting in a shift of labour-intensive manufacturing away from China, he said.

These factors include a desire to locate manufacturing next to consumer markets in the developed world, increased automation that has made labour costs less important, and worries about intellectual property rights protection in China.

"Going forward, the most labour-intensive industries (e.g., some types of high-volume textiles, electronics and furniture) will be attracted to new low-cost areas," he added.

Mexico and other Asian countries, such as Bangladesh, Indonesia and Vietnam, have benefited from this manufacturing drift, with textiles leading the way, said the consultant.

The rise in labour costs has caught the attention of many people in the chemicals industry only over the past three to four years.

But it seems as if China started the shift towards higher-value manufacturing, which is obviously more easily able to absorb higher-cost labour, in 2005 - perhaps even earlier.

"In 1Q 1999, about half of China's exports consisted of nondurable goods. Nondurable goods typically last three years or less and mostly include disposable items and inexpensive consumer goods," said Bjacek. "However, durable goods accounted for about 75% of exports by the 1Q 2013. Between 2005 and 2012 investment in durable goods in China grew by 20% per year, versus 15% per year over the same period for nondurable goods."

Plastics demand growth will slow to less than 8% per year in the medium term and the demand mix will change, said the consultant.

As China tries to move further up the value chain, by becoming a manufacturer of globally recognised branded goods, some nondurable end-use applications for polyethylene (PE), synthetic fibres and polystyrene (PS) might suffer. And if China becomes, for instance, an automobile producer to rival Japan and South Korea, polypropylene (PP), engineering plastics, urethanes, coatings and rubber chemicals will all benefit.

There are lots of "ifs" at the moment when it comes to China, even if most of the serious talk in some chemicals companies is taking place only behind closed doors.

By: John Richardson
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