INSIGHT: Credit cycle will direct China’s PE growth in 2014

06 January 2014 15:53  [Source: ICIS news]

By John Richardson

PERTH (ICIS)--Last year was tremendous in China for anyone in the polyethylene (PE) industry who didn’t listen to the sceptics.

Until as late as early May, there were dire predictions of low single-digit demand growth.

The subsequent surge in apparent demand (imports plus domestic production) left producers and traders scratching their heads as they sought explanations after the fact.

Demand kept improving month-by-month, until by October (see the chart below) it was up 14%.

China PE demand to October 2013What about this year?

A lot could depend on credit cycles.

Back in 2009-2010, when China went on a credit binge to protect itself from the global financial crisis, lending was so abundant that many local traders were reported to have entered the PE  business for the first time.

Last year also saw ample availability of credit – both in the first quarter as shadow bank lending surged and from July when Beijing launched its mini stimulus package.

The problem now, as the surge in short-term interest rates illustrated in December, is that the People’s Bank of China (PBOC) appears to be intent on reining-back bank lending as part of the central government’s economic rebalancing.

Interest rates were said to have gone up because of attempts by the PBOC to force the banks to deleverage. The tool it used was a refusal to inject sufficient cash into interbank lending markets in order to deal with a strong seasonal surge in demand for finance.

There was  a similar credit squeeze last June, but the PBOC relented as the priority shifted to supporting GDP growth in the second half of the year – hence, also, the mini-stimulus package.

But the $64,000 question for China’s PE market and its economy in general, is whether this time Beijing is more determined to control credit growth. This would both help re balance the economy away from investment towards greater domestic consumption, whilst also dealing with a possibly systemic bad-debt crisis.

A concern is that the policy tools to get from point A to point B might involve a great deal of trial and error.

Point A, where China is today, is widely viewed as an economy over-dependent on loans to inefficient state-owned enterprises and ‘white elephant’ infrastructure projects.

Point B is seen as an economy that has both much greater domestic spending, and is more reliant on innovative privately-owned businesses – including higher-value plastics processors.

The danger could be that as policies are tweaked to send lending in the right direction, mistakes could happen resulting in the smaller, innovative processors struggling to source trade finance.

Thousands of plastic processors might, on the other hand, be deliberately starved of credit for strategic reasons rather than because of policy errors, said a sales executive with a polyolefins producer.

“I think it is quite likely that thousands of converters, which make low value products, will be allowed to go bust before the Chinese New Year [31 January]. The government is no longer prepared to write a blank cheque for any inefficient company in any industrial sector,” he added.

A credit shortage, whether accidental or deliberate, could lead to a disorderly destocking process, just as PE supply increases.  The reasons is that the 14% growth in apparent demand might have involved considerable inventory building.

Real, underlying demand growth has been estimated at only 4-6% for the full year in 2013.

The closure of converters could be followed by wave of mergers and acquisitions (M&A) amongst the smaller remaining low-value processors, said the source with the polyolefins producer.

Major distributors may be involved in consolidation through moving into manufacturing, he said.

The government, in its radical reform blueprint released last November, pledged to get rid of “regional and bureaucratic protectionism”.

Part of this process could involve the gradual dismantling of China’s ten or so regional PE markets, resulting in fewer opportunities for traders to make money through arbitrage between different provinces, the source continued.

This year might also see a further decline in GDP growth.

The economy expanded by 7.7% in 2012 and is expected to have grown by 7.6% in 2013, which would represent the slowest rate of expansion since 1999.

If economic rebalancing does, indeed, accelerate, GDP growth could register a further decline.

But PE demand growth won’t necessarily decline in line with lower GDP because of “catch-up growth” in China’s various regions – especially in rural provinces where the government is trying to close the income gap with the wealthier, coastal urban provinces.

Perhaps this catch-up growth will more than compensate for any withdrawal of credit which results in a disorderly destocking process.

Might 2014 also mark the year when China erects more trade barriers to protect its domestic producers?

A business development manager, who works for the same polyolefins producer as the sales manager quoted above, thinks not.

He believes this is a more likely scenario in post-2017, when most of the new US capacity is due on-stream and China has substantially raised its local production.

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By: John Richardson
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