More On China And Stimulus Hopes

By John Richardson

THE fact that the focus has turned to what China might be able to do to once again rescue the global economy reinforces just how important it has become for global growth prospects.

For the chemicals industry it seems as if it is one of the few good news stories around. Other emerging markets offer tremendous potential, but it is the volumes of chemicals and polymers that are already being consumed by China that matter the most.

The West seems set to be mired in multi-year struggles to solve sovereign debt problems. This is likely to keep consumer spending at extremely depressed levels as governments cut back on entitlement programmes, increase taxes if politics allow and perhaps even raise retirement ages.

There is much talk about China’s economy being driven by too-much investment in industrial capacity with consumer spending as a proportion of GDP (gross domestic product) declining over the last decade. Michael Pettis, finance professor at Peking University’s Guanghua School of Management and author of the China Financial Markets blog, goes as far as to warn that China has indulged in such an investment binge, leading to a major misallocation of capital, that in a couple of years’ time the country will start to see sub-par economic growth.

But the recent growth numbers have been quite staggering. Polyethylene (PE) demand rose by a staggering 53% in 2008-2010, according to Paul Hodges of International eChem.

And despite a clear slowdown in PE demand growth on tighter credit conditions, the underlying seemed to be demonstrated by GDP growth of 9.1% in the second quarter – above the expectations of most analysts.

Beijing is also awash with reserves – some $3.2 trillion – and so it is well able to launch another economic stimulus programme on the scale of late 2008.

Back then, when the world economy seemed near total collapse, central and local government infrastructure spending and a doubling of bank lending, led to the 53 per cent rise in PE and double digit demand growth for numerous other chemicals and polymers. This was a boon for overseas producers as every spare molecule was shipped to China.

Now, though, the concern is that problems left over from that huge stimulus package make a repeat very unlikely. Anything approaching the same scale of government spending would increase the likelihood of the Michael Pettis prophesy coming true.

One of the most obvious left-over consequences of the stimulus programme is inflation which has yet to peak.

Many financial analysts had expected the risein the cost of living to start tapering off from the second half of last year. Now they expect this to occur at some point in H2, but the inflation rate was 6.5% in July, up from 6.4% in June. July inflation was the highest in three years.

State-owned banks were told to go out and lend as much as they could from late 2008 onwards in order to reverse the rise in unemployment, leading to lots of money pouring into speculation in chemicals, other commodites and crucially, the real-estate sector.

It is this hot money that is partly being blamed for persistently high inflation, although food prices are still a major driver of the rise in the cost of living. Food prices should come down later this year when temporary supply problems have been resolved, is the theory.

But the official policy of the People’s Bank of China remains bringing inflation below the government’s target of an annualised rate of no more than 4% for 2011.

“Until or unless that policy is changed interest rates are not going to come down and credit is going to remain restricted,” said a Hong Kong-based polyolefins trader.

Controlling inflation is a top priority because of the threat that rising costs presents to social stability.

A further reason to doubt whether China can ride to rescue of the global economy is the number of bad debts left over from the last stimulus package.

Local governments played a big role in the package as they built railways, airports and roads and invested in real estate.

Beijing has released figures showing that borrowings by Chinese local governments had climbed to 10.7 trillion yuan ($US1.65 trillion) in debt, equal to a staggering 27 per cent of China’s GDP.

Some analysts have warned that local government debt as a percentage of GDP is much higher than 27 per cent – and that the country’s total liabilities could even be in excess of 100 per cent of annual output. This would put China in the same category as basketcase economies such as the US, Japan, Italy and Greece.

China might therefore only have the flexibility to introduce a few relatively minor, targeted measures designed to compensate local manufacturers for weaker Western demand.

Polyolefin producers and traders hope that small and medium-sized enterprises (SMEs) might be helped. The SMEs , which make up the bulk of the buyers of chemicals and polymers buyers in China, have been hurt by tighter credit, higher interest rates and rising wages costs.

But modest support for certain industrial sectors is obviously not going to deliver anything like the same demand boost the chemicals industry enjoyed in late 2008.

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