Misplaced Faith In China Recovery

By John Richardson

WEAKER domestic consumption-growth in China represents a major challenge to the argument that global petrochemicals demand, and therefore pricing, will see a strong recovery during 2011.

Price declines continued last week with low-density polyethylene (LDPE) down a further $20-50/tonne as the polymer, as we have reported before, continues to be dogged by high inventory levels.

Polypropylene (PP) prices fell by $10-40/tonne with further reductions seen as inevitable. Like LDPE, PP increased too rapidly and by too much as a result of feedstock costs and supply issues.

These reductions follow declines a week earlier in both Asia and Europe. We will take a look at the latest state of European markets in a separate post over the next few days. 

Some slight good news was that high-density PE (HDPE) pricing stopped falling last week, while linear low-density PE (LLDPE) edged-up by $20/tonne.

However, a trader told us this morning: “Nobody really believes that HDPE or LLDPE pricing has bottomed-out. Buyers remain exceptionally negative as they anticipate further price reductions.

“And anyway, even if their sentiment had improved, many of the end-users wouldn’t be able to get the financing to replenish their stocks because of all the credit-tightening measures.”

The extent to which credit-tightening is undermining efforts to rebalance the economy away from exports became very apparent last week.

Retail sales growth slowed to 16.9% during May. Even though this number was inflated by high food prices, it was still less than the average for the last five years.

Passenger-car sales declined for the first time in two years as growth in furniture and electronics sales dipped.

Meanwhile, spending on fixed assets and investments rose by 26%, excluding rural households – the fastest pace in almost a year.

This suggests that the enormous economic stimulus package, introduced in late 2008, continues to feed through into fixed-asset investments. How much of these investments will ultimately be productive versus additional inefficient loss-making factories and even-more empty condos?

The rise in fixed-asset investments is hindering the economic rebalancing effort: Private consumption has now fallen to 34% of GDP, the lowest level since China began to open-up its economy more than three decades ago, according to this article from Bloomberg quoting Capital Economics. Ten years ago, private consumption represented 46% of GDP.

Higher wages should eventually improve this ratio, but not until the Chinese government has won the battle against inflation.

The fight to reign- in the rising cost of living is, as we have already pointed out, hurting consumer spending – and the situation is likely to get worse.

“The government is caught between the devil and the deep-blue sea,” a senior source with a global polymer producer, who heads his company’s Greater China operations, told us recently.

“It has to bring the overall inflation rate below 4% in order to maintain social stability, but this target will not be met this year. As a result, we expect further interest-rate rises and credit-tightening measures.”

Overall inflation was at 5.5% in May, the highest in 34 months, with food prices up by 12% – prompting the government to raise bank-reserve requirements by a further 50 basis points to 21%. This was the sixth increase in the reserve requirement so far this year.

Interest rates have been increased on four occasions since last September, but financial analysts worry that an 11-week gap since the last rate rise has been a mistake. Another 2-3 interest-rate increases are, as a result, forecast for 2011.

Polyolefin industry players continue to express the hope that Chinese demand will soon return with avengeance after a five-month lull.

But if domestic consumption remains depressed, which seems likely given the protracted struggle with inflation, how can a big recovery happen?

Some kind of rebound might occur as China enters its peak manufacturing season.

But as we discussed last week, the downside of higher wages is reduced export competitiveness. Migrant-worker wages were raised by 40% in 2010 and are expected to be increased by an additional 20-30% over the next three years.

The peak manufacturing season is also likely to be affected by power-supply problems and, of course, again restricted credit – which makes it ever-harder for export-focused companies to raise trade finance.

Perhaps, though, the biggest reason for caution about a strong Chinese recovery is that it seems to be dependent more on external rather than internal factors.

Anybody betting on a rebound would therefore need to place his or her faith in stronger US and European economies.

US unemployment is back above 9% and the Eurozone is in crisis as a result of Greece, making any such leap of faith difficult for us to understand.  

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