China Inflation Threat To Chemicals


Sky-high living costs?

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By John Richardson

CHINA’S imports surged by 55.9 per cent last December, raising concerns among chemicals traders and producers that this points to increasing inflationary pressure and a possible interest-rate hike later this year.

The country’s current official borrowing rate stands at 5.31%.

“The government has indicated in several official statements that it’s concerned about inflation. If borrowing costs go up we would very likely see a dip in activity in sectors such as real estate that hugely buoyed chemicals and polymers demand in 2009,” said a Singapore-based source with a leading global polyolefin producer.

“Pro-active” fiscal policies and “moderately loose” monetary policies would, however, be maintained in the near-term said China’s president Hu Jintao at the weekend.

Real-estate construction is nevertheless up by more than 50% from a year ago, according to the same article from the Sydney Morning Herald which we quoted in our blog post earlier today.

Property prices have surged over the last 12 months, raising apparent government concerns over an asset bubble and affordability for average earners.

The same article, quoting the Beijing-based Institute of Population and Labour Market Economics at the Chinese Academy of Social Sciences, said that the labour markets were now once again tight after the big migrant-worker layoffs in 2008 and early 2009.

So is inflation really that much of a threat?

Expectations of inflation matter a lot as these drive consumer behaviour, leading to pre-buying of everything from oil and chemicals to food.

Prices of garlic and dried chili peppers have already been driven up in China by speculators anticipating price rises, said Alaistair Chan, Sydney-based associate economist for Moody’s, in this Los Angeles Times blog piece.

The price of food is vital for social stability in China. The wider threat of rising food prices across Asia – because of poor harvests and increasing energy costs – is a subject we will revisit in more detail in later posts on this blog.

The same LA Times blog posting – and again the article in the Herald – point out that The People’s Bank of China began selling its three-month bills at a slightly higher interest rate last Thursday for the first time since August.

This was aimed at mopping up excess liquidity brought on by the $1.35 trillion in new loans issued between January and November last year – and could indicate less new loan-growth in 2010 as part of efforts to tackle inflation, the blog added.

“There is good reason to view the rise (in the sale price for the three-month bills) as a precursor to further tightening,” said Ben Simpfendorfer, chief China economist for the Royal Bank of Scotland in the same posting.

Consumer price index inflation (CPI) reversed from a 2.0% drop year-on-year to a 0.5% increase during the first three quarters of last year, he added.

But Morgan Stanley argues in this article in Finance Asia that while the CPI and the production price index are likely to rise early in 2010, China’s year’s average inflation rate will only be 2.5%.

Inflationary pressure will not be as great as some market participants expect because the growth in money supply – which we referred to earlier today as proxy for credit and spending growth – is to some extent misleading, the bank added.

Strong M2 growth failed to take into account the change in M2 caused by the shift in asset allocation by households between cash and stocks, said Morgan Stanley.

As equities or so unstable, therefore, a rise in share prices won’t necessarily mean a big jump in consumer spending.

The other reason given by Morgan Stanley for inflation remaining under control as current conditions stand – meaning a low risk of an interest rate hike later this year – is what it forecasts will be a weak export market in 2010.

In the same set of official government data that indicated the steep rise in December 2009 imports, a 17.7% rise in exports was reported for the same month.

This was the first time in 14 months that China’s exports had increased, according to this piece from the Financial Times.

If a strong export recovery is sustained during the next few months, this might raise pressure on the Chinese government to return to its policy of gradual Yuan appreciation, said Andy Rothman, CLSA’s chief China economist, in the same article. CLSA is a Hong Kong-headquartered investment and brokerage firm

He believes a sustained recovery would give China’s government the political cover to raise the value of the Yuan against the dollar by 3% in 2010.

A real recovery in exports would be a return to the volumes China enjoyed in 2007 and the first half of 2008.

(A return to dollar values wouldn’t be necessary as China’s exporters have received boosts from tax rebates and the fall the value of the Yuan against currencies other than the dollar because its been re-pegged to the greenback)

I am with Morgan Stanley on this as I cannot see how China’s exports can recover to pre-crisis levels in 2010 because of deep-seated problems with Western economies.

So the odds seem to be long on a rate rise.

But if loan growth is reduced this year, this will still have a negative effect on chemicals demand.

What’s hard to gauge is the impact on chemicals of a widespread belief that Yuan appreciation will not take place this year – the result of exports failing to rebound sufficiently. 

(The more that exports recover the greater the pressure from the West on China to raise the value of the Yuan. Higher interest rates – the result of the inflation we’ve been talking about – might also be accompanied by a stronger local currency) 

As we’ve written about before, the prospect of a 2010 appreciation led to lots of strange speculative trading in chemicals in 2009.

This added to the optimistic mood, but didn’t always necessarily represent real (whatever “real” means!) demand growth.

Yuan appreciation will have to resume at some point.

So those in for the long term would continue to maximise their local currency revenues, while those with a shorter horizon would cut back on their exposure.

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