China’s “Overwhelming” Overcapacity

By John Richardson

A HOPE being expressed by chemicals and polymer traders and producers the blog has spoken to this week is that the surge in lending in China during the first quarter will result in stronger GDP growth later this year.

Total new financing, which includes both official bank loans and lending via the shadow-banking system, increased by 58% in the first quarter of this year over the same period in 2012.

This kind of thinking is also being applied to the resources sector.

The idea is flawed, we believe, because a great deal of the new money sloshing around the economy is likely to have found its way into servicing existing debts, as this Reuters article points out.

Equally flawed is the notion, being put forward by some South Korean cracker operators, that a big new stimulus programme will be launched in H2. Instead, rebalancing is the priority, as we discussed on Tuesday.

And returning to the perhaps rather perverse view that surging credit growth in Q1 is actually good news, the rise in lending is producing diminishing returns, as we again discussed on Tuesday, and has created a major bad-debt problem.

A further reason to doubt that the rest of this year will see better growth than in Q1 is the continued depressed mood amongst manufacturers, resulting from major overcapacity problems.

“As the structural adjustment in the economy goes on, overcapacity in a number of industrial sectors remains overwhelming, restraining the pace of cyclical recovery,” said JPMorgan chief China economist Haibin Zhu in a research note.

Chen Letian, an economist at Rising Securities in Beijing, estimated that the average factory capacity utilisation rate in China was just 57% in 2012.

Overcapacity is a problem in several petrochemicals. Polyvinyl chloride (PVC) is one of the most prominent examples. Operating rates were just 55% in 2012, according to ICIS China.

Methanol, too, is affected by oversupply with butadiene also facing a potential big surge in capacity during 2012 which could leave the market very long. We shall look at both of these products in detail in later posts.

Many industries are oversupplied because of the investment-led growth model that has resulted in excessive spending on not only new factories, but also infrastructure.

It is not only overcapacity that will continue to exert margin pressure on manufacturers. Wage costs are set to remain on an upward trajectory.

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