By John Richardson
ECONOMISTS, financial analysts and ratings agencies are increasingly lining up to say what we have believed since last November: China’s new leaders are so serious about economic reform that they are prepared to sacrifice short-term growth for the sake of rebalancing the economy.
The barrage of further commentary over the weekend, supporting the new consensus view on China, was in response to what the Financial Times says was last week’s firing of a “warning shot across the bows” by China’s central bank – the People’s Bank of China (PBOC).
The PBOC had allowed short-term money market rates to soar to a record high of 28% at one point last week, before an injection of liquidity saw rates substantially ease.
“Until late last week the central bank had consistently injected just enough cash in the banking system through its regular bond auctions to keep money market and lending rates within its target range,” wrote the FT in the article we have already linked to above.
“When rates started drifting upwards, most analysts and investors predicted the central bank would step forward with fresh cash. It did not.”
What would have been more useful, we think, is if the majority of commentators – and also some chemicals companies who have got their 2013 growth forecasts for China so badly wrong – had seen the fundamental changes taking place many months ago.
This second FT article is worth a close read as it reports what the state-owned Xinhua news agency has said about last week’s deliberately engineered credit crunch.
In summary, Xinhua said that:
*It wasn’t that there was lack of financing in the system as a whole, it was just that money wasn’t being properly spent.
*While banks, the stock market and small and medium-sized enterprises (SMEs) lacked money, the broad money supply M2 had still expanded by 15.8% compared with the same period last year, new loans were still high and total social financing aggregate, a broad liquidity measure, continued to grow rapidly in the first five months of this year. This indicates that the crackdown on the shadow-banking system, which represents a systemic risk to China’s whole banking system, is going to carry on.
The good news for the reform process is that in a separate statement, the PBOC said that it would try to improve liquidity management in order to let money better serve the real economy and support economic growth.
What we think this means for the chemicals industry is as follows:
*If the PBOC succeeds in its objective to improve the efficiency of credit allocation, this will help China’s hard-pressed SMEs, which are struggling with not only expensive credit, but also rising labour costs, labour-supply shortages and deflation. But the PBOC has a battle on its hands against the vested interests that want to prevent reform of the dysfunctional lending system. It is the SMEs which make up the bulk of chemicals and polymer buying in China, and so success would clearly be good news for demand. But total success is not going to happen anytime soon.
*Volatility is bound to continue because of the uncertainty and insecurity generated by China’s radical change of course. Hence, at the weekend, despite Friday’s liquidity injections, the second FT article adds that “when a technical glitch caused by a long-planned software upgrade at Industrial and Commercial Bank of China made cash withdrawals impossible for almost one hour at the bank’s ATMs, many consumers fretted that one of the biggest state lenders was in trouble.” Any improvements in chemicals and polymer buying by end-users will, therefore, remain very fragile for at least the rest of this year. The dominant approach to purchasing will remain “hand to mouth”.
*Speculators will also remain largely on the sidelines, as we discussed in last Friday’s post. Skimming off the speculative froth from growth forecasts is a key challenge of chemicals company corporate planners. Plus, any further scares over changes in policy indirection run the risk of causing traders to swiftly liquidate inventories, driving prices down.
*China, as it forges ahead with reform, will struggle to achieve its 7.5% GDP growth target for 2013. We think that even 6% growth this year could be hard to achieve.