INSIGHT: China govt spending, credit clouds real demand picture

04 November 2013 14:23  [Source: ICIS news]

By John Richardson

PERTH (ICIS)--The short-term specifics of supply in any particular petrochemicals value chain are, of course, enormously important for working out what is going to happen over the next few months.

Thus in polyethylene (PE) in China right now, tight supply has kept markets firm.

Outages, and lower-than-expected operating rates at plants brought on-stream this year, have reduced high-density PE (HDPE), linear low-density PE (LLDPE) and low-density (LDPE) availability.

Now, as these outages come to an end, there is growing concern over new capacity scheduled to start-up during the next 2-3 years.

But there is another aspect to assessing short-term markets that has become much more important in China over the last six years, say industry sources.

It is the ebb and flow of Chinese government spending and credit that encourages traders and end-users to stock-up and de-stock – thus making it harder to separate apparent demand (imports plus domestic production) from real demand. Real demand is when inventory effects have been discounted.

The reason why government spending and credit are playing a bigger role in China is because of the start, stop and start again nature of central government economic stimulus, the sources add.

First, there was the huge economic stimulus package of late 2008 and then the tightening period from April 2011 until around July of this year as Beijing battled inflation. Since July, stimulus has kicked in again, even if the latest package has been described as “mini”.

It is the chemicals and polymers that are relatively easier to store that seem to be the most vulnerable to these cycles. Because they are easier to store they are viewed as easier to trade.

Hence PE, other synthetic resins – and also monoethylene glycol (MEG) – have been singled out as particularly vulnerable to people going long, sometimes excessively so, when lots of government-funded infrastructure projects are in the pipeline and financing is plentiful.

There is another long-running complication that also has to be fathomed out: Some plastic converters are said to regularly switch between producing their end-products and re-selling synthetic resin raw materials (i.e. they temporarily become traders), depending on what will yield the best returns.

The number of converters which act as part-time traders is reported to have risen over the last six years.

This has been attributed to ample availability of credit and rising labour costs.

Higher labour costs have made it harder for low-end converters to compete in some plastic products markets. Some end-users have closed-down operations and moved to lower labour-cost locations, such as Vietnam, whilst others are said to have stayed in business through part-time trading.

So, what about the current government investment and credit cycles and what they mean for demand next year?

Phat Dragon, the China analysis service provided by Australia’s Westpac Securities, thinks that spending by Beijing has already peaked.

“The predictable cresting and then decline in the growth rate of railway investment is now conclusively underway, and will be a drag on the (progressively broadening) categories of transport, infrastructure and tertiary industry capex through the end of this year and in the first half of 2014,” wrote Phat Dragon in an October report.

“The factors holding up those important categories, in the face of the rail slowdown, have been accelerating outlays on highways and continued high growth in the strategically important (and massive) utility and environmental management complex.

“Yet even here there are signs that a peak in growth rates has been reached. Phat Dragon observes that the growth in the value of new projects across the urban economy has slowed quite abruptly, to be well below that of ongoing work, implying that the pipeline is being replenished at a rate that is insufficient to maintain current growth rates.”

These views were supported by several economists who commented on last week’s release of China’s official purchasing managers’ index for October.

The official index’s headline reading rose to 51.4, from 51.1 in September, but its new orders sub-category fell to 52.5 from 52.8. This has been interpreted as a sign that government spending has, indeed, peaked.

“Details show that the headline increase was led by stronger output, but new orders and new export orders both pulled back in October,” wrote Jian Chang, Jerry Peng and Serena Zhou of Barclays in an investment note quoted in a 1 November post on the Wall Street Journal blog, Real Time Economics.

And they said that further government spending seemed unlikely over the next few months. They also forecast tighter lending conditions.

“Fundamental challenges, including industry overcapacity, mounting local government debt, rising financial risks and the property bubble, will constrain policy options and we have been expecting a neutral monetary policy stance with a tightening bias since August,” the analysts added, in the same note.

One related theory is that the mini-stimulus package was partly introduced to boost economic growth, and, as a result, political support ahead of the crucial November plenum. The dates of the plenum have now been set for 9-12 November.

Now that this support has been built the government will be in a stronger position to introduce painful economic reforms during the plenum, which will involve less rather than more economic stimulus, argue some economists.

Still, though, if GDP (gross domestic growth) starts slipping below government targets in 2014, yet another stimulus programme cannot be ruled out.

But against this counter-argument are the diminishing returns from the investment-driven growth model.

Plus, as Barclays has highlighted above, mounting debt problems might make a new stimulus package even less likely.

Read John Richardson and Malini Hariharan's Asian Chemical Connections blog

By: John Richardson
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