China Lending Bubble Adds 4.7m Tonnes To Polyethylene Consumption

PE2

By John Richardson

THE IMF produced a very interesting study earlier this month, in which it estimated that if it had not been for China’s giant economic stimulus programme the country’s real GDP growth would have averaged only 5.3% per annum during the five years to 2016. Instead, however, the IMF estimates that China’s economy actually grew by an average of 7.3% during those years. Real GDP is GDP adjusted for inflation and deflation.

Let’s use this as a basis for what might have happened to Chinese polyethylene (PE) consumption in the ten years from January 2007 until the end of 2017. What if there had again been no huge economic stimulus programme?

Working on nominal GDP numbers only for those ten years I took the average 9.3% annual growth that ICIS Consulting expects during this period down to 7.3% (nominal GDP is GDP unadjusted for changes in prices). I then used slightly lower multiples of PE demand growth over GDP to reflect less availability of new credit. I ended up with two very different pictures for consumption growth between 2007 and 2017 (see the above chart).

Our base case is that consumption will have grown to around 27m tonnes by the end of this year (the blue line). But in my counterfactual view of China’s PE market, PE consumption would have been at around 22m tonnes by end-2017 (the orange line). This is a 4.7m tonne difference when you look at the exact numbers.

What I cannot estimate is what would have been the knock-on effect on the rest of the global PE business of the absence of 4.7m tonnes of Chinese consumption growth, but there is no doubt that the impact would have been substantial. If Beijing hadn’t conducted the biggest economic stimulus package in the history of the world then the rest of the global economy would have struggled. China essentially rescued the global economy from what would otherwise have been a far more severe Global Financial Crisis.

Think of the economies closely tied-in to China’s economic ecosystem. What would GDP and so PE consumption growth have been like in major resource exporters to China such as Indonesia, some countries in Africa and Australia? No big stimulus package and there would have been no boom in resources pricing and demand. We also have to consider the manufacturers of high-value finished goods, such as Germany and the US. How many BMWs and I-Phones would have been sold, absent again this big stimulus programme?

What Happens Next

There has been a lot of talk of a decoupling of PE demand growth in China from GDP because of booming consumer spending, especially on internet sales. The theory is that even if China’s GDP growth moderates considerably over the next few years, polymers demand growth in general will be fine as the multiples of polymers growth over GDP are increasing.

Normally at this stage in a country’s economic development, multiples of polymers growth over GDP start to fall. But not in China because of the surge in consumer spending, particularly for goods bought over the internet which require lots and lots of plastic packaging, according to some analysts.

But just how sustainable is today’s growth in consumer spending? Deutsche Bank, in a report released last week, wrote:

If we focus purely on the consumer lending … then China has been undergoing something akin to a consumer lending frenzy.

As the expansion in corporate borrowing slows down on reduced lending growth, consumers seem to be filling the gap. Deutsche Bank estimates that short-term consumer credit is growing at 35% every month on a year-on-year basis and could reach 40% by December.

Beijing surely doesn’t want to replace a corporate debt bubble with an equally damaging consume-lending bubble. And the two are linked. As companies borrow more and more money to pay down existing debts – a “Minsky moment” – a lot of this additional debt is being repackaged and sold into consumer-lending markets as wealth management products (WMPs). The government is in the process of clamping down on WMPs, as they are the core of the highly speculative and so very risky shadow- banking sector.

We also don’t know to what extent the decoupling of polymers growth from GDP is down to an early stage in the product life-cycle of internet sales. Right now, the priority of Alibaba and Tencent etc. is to win and keep market share, and so they are not going to skimp on plastics packaging material. Goods simply must arrive in one piece. And with oil prices so low plastic packaging takes up a very small share of the total cost of delivery. But what happens when competition and cost consciousness increase in the Chinese e-commerce space? And what about a bigger customer and government pushback against additional plastic waste?

We also don’t know what the impact will be on consumer spending, and the economy as a whole, of the deleveraging now taking place in the corporate sector. This is leading to a shutdown of surplus capacity in steel, aluminium and some chemicals and polymers – and when factories shut down then of course people lose their jobs.

This FT article is also worth close consideration as it makes the point that China is more reliant on fixed-asset investment for its growth than any other major economy. Up until 2015, fixed asset investment was largely been drive by new industrial capacity, but not since that year because of oversupply across many industries. Infrastructure spending has instead been the major driver.

Now, though, Beijing appears to be clamping down on infrastructure spending because building bridges, roads and rail links etc. has been responsible for an alarming rise in local government debts. Reforming local government financing was identified as a major objective back in late 2013. But perhaps only now is Xi Jinping in a position to properly deal with this objective.

China’s economy is no different from any other economy as it is made up of lots of interconnected parts. Slow growth down in one sector and other sectors are at risk. Your scenario planning for future levels of PE demand growth in China must therefore take on board the potential for a substantial downside.

, , , , , , , , , , , , , , , , , , , ,