Market outlook: China's growth slowdown will have ripple effects

22 November 2013 09:53  [Source: ICB]

There are many reasons to be negative, or perhaps realistic, about the outlook for China chemicals demand growth and the impact on the rest of Asia

Last year, polypropylene (PP) demand in China totalled around 16.5m tonnes, according to ICIS Consulting. Its nearest Asian rival was India with consumption of around 3m tonnes.

It is the same just about everywhere else you look. China’s rapid industrialisation has led to consumption across a wide range of chemicals and polymers that dwarfs that of any other developing economy in Asia.

 

 China growth slowdown has ripple effects

Copyright: Rex Features

The disparity with India is most striking because their populations are similar. India’s population was 1.2bn compared with China’s 1.3bn as of November this year, according to US government statistics.

The explanation as to why India is so far behind China in terms of chemicals demand is well known. India’s restrictive labour laws, poor infrastructure and cumbersome legal system have stymied growth of downstream manufacturing industries that might have consumed far more chemicals.

In China, the exact opposite has applied. Flexible labour laws, plus abundant cheap labour, great infrastructure and a legal system that is told what do by central and local governments keen on manufacturing have resulted in extraordinary growth rates in chemicals demand over the last two decades.

DISAPPOINTING GROWTH RATES
“This is the context everyone needs to bear in mind when they get excited about the prospects for compensating growth in developing Asia ex-China, if China continues to slow down” said a Singapore-based chemicals industry executive.

“True, percentage wise, India and Indonesia, etc, might continue to see excellent growth rates, but will anywhere ever replace China as the main engine of actual consumption by volume in Asia? The answer is ‘very probably not’, certainly not in my working lifetime,” the executive added.

The great news, though, is that even if China’s chemicals demand growth does continue to decelerate, the consumption base is now so big that there will still be significant growth in the extra volumes required, say several other chemicals industry executives.

But there is growing anxiety that China’s growth rates will disappoint – both in percentage and volume terms. Chemicals companies are concerned that China’s economic slowdown will be more severe and longer in duration than they had anticipated only 12 months ago.

We have discussed the reasons for this change in outlook several times before in this column. Suffice to say here, therefore, as a reminder: There could be a very painful “chemicals demand-growth gap” as China attempts the transition from an investment and export-focused to a domestic-led economy.

PROJECT IMPACT
One result of disappointing growth rates in China might be that some new capacity will not come on line elsewhere in Asia.

“I cannot see all of the refinery and petrochemicals projects planned in southeast Asia [SEA], which are due for start-up after 2017, going ahead. I think some hard decisions will have to be made,” said a source with a petrochemicals logistics supplier.

At the same time, though, it is a widely assumed that many of the projects being planned in the US post-2017 will happen – because of their big ethane feedstock advantage.

In a lower China growth environment, this could exert a lot of pressure not only on new projects elsewhere in Asia, but also on existing plants.

“I cannot see how some of the existing plants in northeast Asia, and some of the plants and projects in SEA, can be competitive after 2017, unless import barriers are erected,” said an executive with a global polyolefins producer.

“US ethylene costs at the new plants will be just $300-400/tonne, whereas costs in SEA will range between $900-1,200/tonne.”

This cost differential would become ever-more important as polyethylene (PE) and other ethylene derivatives became oversupplied, he added.

WIDER ECONOMIC ISSUES
A further concern is that existing petrochemicals capacity in China will become harder to absorb. In some chemicals and polymers, China is already in surplus and is thus an exporter. The lower that local demand growth falls, the worse might be the disruption from these exports.

Polyvinyl chloride (PVC) is a good example. Average operating rates in China were only around 55% in 2012, according to ICIS China.

China’s PVC data for January-September this year compared with the same period in 2012 shows the scale of the current problem.

Demand grew by just 2% as local production increased by 12%, according to data from Global Trade Information Services.

Meanwhile, recycled imports fell by 74%, imports of virgin material were down by 17% and exports surged by 55%.

What also worries China’s competitors is that what they call the country’s “hidden,” or “not so hidden” subsidies that continue to make its petrochemicals exports very competitive. These include the cheap cost of financing and low-cost energy.

As for downstream manufacturing industries in China, the same subsidies seem to also apply. China has ended up with overcapacity in downstream products such as finished biaxially oriented PP (BOPP) film, thanks to overinvestment in state-of-the-art, large-scale processing lines.

In a weaker growth environment, this could make it harder for competitors in countries with inferior economies of scale to compete. Competitors in the ASEAN region are thought to be especially vulnerable because of reduced import tariffs from China following the launch of the ASEAN-China Free Trade Area in January 2010.

And finally, on the negative side of the equation, concerns are growing over the distorting impact that easy Chinese, and also US Fed credit, has had on the rest of Asia.

“Rock-bottom interest rates in the US, Europe, and Japan, combined with the Federal Reserve’s multi-trillion dollar quantitative easing programmes encouraged $4 trillion of speculative ‘hot money’ to flow into emerging market investments over the past four years,” wrote US-based economist Jesse Colombo in a 15 October article in Forbes magazine.

“Soaring demand for emerging market assets led to a bond bubble and ultra-low borrowing costs, which resulted in government-driven infrastructure booms, alarmingly fast credit growth, and property bubbles in numerous developing nations,” Colombo said.

And he added that many emerging-market economies have also benefited from high commodity prices, thanks to China’s aggressive credit-fuelled infrastructure spending boom that began in late 2008.

20 YEARS OF GETTING IT WRONG
Easy credit has led to soaring consumer spending and consumer debt levels in countries such as Indonesia, Malaysia and Thailand. Property prices have also in some cases tripled over the last six years.

If and when the US Federal Reserve starts to taper quantitative easing is a separate issue, but it is obviously crucial for growth prospects across Asia.

So is the timing of any Chinese decision to cut back on its stimulus spending. Some economists think that the benefits of the “mini stimulus package”, which was launched in July, are already beginning to fade.

And they think that further major stimulus measures are unlikely in 2014, because of rising bad-debt problems and diminishing returns from the investment-led growth model.

But as Financial Times columnist Gideon Rachman wrote in a 4 November article, negativity over China has long been popular – and has long been wrong.

“Predictions that the Chinese economy is about to crash – or that the political system will soon implode – have been a regular feature of outside analysis of China for 20 years and more,” he said.

“So far the country’s political leadership has regularly proved the sceptics wrong. Given that record, it would be a brave person who bet against the success of the Xi [Xi Jinping, China’s president] reform programme.”

In our next China column, we will therefore attempt to rebut all of the above negativity with a much more positive scenario for China.


By: John Richardson
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