The China Recovery Conundrum


Good news, bad or indifferent? It was hard to gauge a clear picture from the Q1 macroeconomic numbers for China.

While retail sales grew at 14.7% in March compared with 11.5% in February, exports fell 20% during the first quarter.

GDP (gross domestic product) growth was 6.1% for the whole quarter, less than half of the pace at which the economy was expanding in md-2007.

Prime Minister Wen Jiabao has warned against “blind optimism” over the speed of the recovery, according to the New York Times. He cited weak overseas demand, overcapacity in some industriess, job losses and low investment in the private sector as the reasons why the foundations for recovery were not solid.

Export trade won’t recover until the Western consumer starts spending again close to pre-crisis levels. Without such spending it might be reasonable to assume that China will struggle to post any further years of double-digit growth.

Overcapacity in some industries includes petrochemicals, although markets have been kept tight temporarily for reasons we’ve already covered in this blog.

The huge government spending programme planned for refining and petrochemicals could worsen the overhang.

China’s petrochemical self-sufficiency ambitions could force all but the Middle East and a few other low cost producers out of being able to export some products to China.

I noticed in this Economist article that industrial production was sharply up in March by 8.3% and I read elsewhere that factory gate prices slipped by 6% – again in March – from 4.5% the previous month.

I’ve picked up anecdotal reports – again mentioned earlier on this blog – that factories are running hard in the textiles and garments sector to keep people in jobs, aided up soft banks. This conjures up an image of rows of warehouses stacked high with shirts that nobody wants to buy.

Is there a danger that in H2 China will export deflation to relieve some of its finished-goods inventory pressures? If so, what would this mean for the business of chemicals?

A sure way of telling might be a survey of purchasing managers in the West, asking whether they have been offered unusually large quantities of very cheap Chinese goods.

Jun Ma, Deutsche Bank’s Chief Economist for Greater China issued a note this morning about the possibility of restrictions on the growth in loans because of poor lending practices.

This followed a warning against credit risks by Liu Mingkang, chairman of the China Banking Regulatory Commission, which this Wall Street Journal article has also picked up.

There are widespread anecdotal reports of commodity chemicals prices being over-inflated because easy lending has made it easier to speculate.

This speculation is across chemicals and polymers, futures exchanges for chemicals and polymers such as the Dalian Commodity Exchange and prroperty and stock markets. The same trader can often be dabbling in all the above.

One of my good contacts and friends had a “Joe Kennedy” moment last week (this refers to the famous story where the father of John F Kennedy was advised to invest in stocks by a shoe shine boy. He promptly went out and sold his shares just in time to avoid the Wall Street Crash).

The trader’s moment came when he was asked by a Bangladeshi customer for ten full container loads of polyethylene (PE).

“I knew something was very wrong because there is no way demand in Bangladesh would justify this size of shipment. It was obvious this was for speculation,” he said.

This followed a call from a Chinese chemicals trader who had never traded in polyolefins before asking for a cargo on behalf of a friend of a friend. “It was obvious he knew nothing about melt indices, the product or its applications. I could hear the sound of the herd stampeding towards the edge of the cliff.”

So the trader liquidated all his positions late last week ahead of what he thought would be sharp price falls in polyolefins in China. It will be interesting to see if he was right.

In the longer term, as the Economist article also points out, better infrastructure – a major feature of the stimulus package – will help boost domestic growth and reduce reliance on exports.

If the government also manages to introduce a good nationwide health and social security system, domestic growth could really accelerate. I would bet that China has a much better chance of success than the US.

But China is China and if there is a way of making money out of a crisis, the famously savvy Chinese traders will find a way.

The danger is that this sends misleading signals about the true state of demand to outsiders – and at the moment, we are all desperate for any bit of good news. Has this made us a little more gullible than normal?

Speculative bubbles in property and construction – brought to an end by credit restrictions- was the start of the country’s economic decline, The Economist adds.

Government policy was wrong.

If factories at the end of some chemical product chains are being kept running at high operating rates for social rather than demand reasons, this could turn out to be another flawed policy.

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