Market Intelligence: China's credit crisis - real or not?

07 February 2014 10:15 Source:ICIS Chemical Business

The consensus amongst most economists insists that the country’s economy will continue to grow at a healthy rate. But a debt crisis could threaten that, according to some observers

China’s petrochemicals markets have grown hugely in terms of volumes over the last 10 years.

And so, even if the country’s GDP (gross domestic product) growth keeps on slipping, nobody should perhaps be that worried, as lower growth would be off much bigger bases of consumption.

 

 Spending is fuelled by growing levels of private-sector debt

Copyright: Rex Features

For example, in 2003, China’s high-density polyethylene (HDPE) consumption was around 4m tonnes, according to ICIS Consulting. In 2013, it had reached approximately 9m tonnes.

This is how several polyolefins producers look at China in 2014 and beyond.

They also assume that the “debt crisis” that has grabbed so many headlines over the last few weeks isn’t really a crisis because China has high domestic savings rates, a big current account surplus and huge foreign-currency reserves.

This means that even if the most pessimistic estimates of bad debt are accurate, the country has ample cash to bail itself out.

Their optimism is very widely shared, according to Ruchir Sharma, Head of Emerging Markets at Morgan Stanley Investment Management.

“It is hard to find a prominent economist who forecasts a significant slowdown, much less a credit crisis,” he wrote, in a 28 January article which appeared in several major newspapers.

The consensus view was built on the idea that because China had always found its way through big economic problems in the past, it would do so again, Sharma added.

This was reflected in the outlook for GDP growth, he said – an outlook shared by several polyolefins producers.

“China has hit its ambitious GDP growth targets so consistently that many analysts can no longer imagine a miss,” he wrote.

“Consensus forecast is for annual GDP growth to hit 7.5% this year, right on target, and to continue at an average rate of 6-7% for the next five years.”

Even if the days of double-digit GDP growth are behind China, growth of around 7% would still be pretty spectacular – especially as petrochemicals markets are so much bigger.

Here is another example: Linear low-density (LLDPE) consumption was just 2.5m tonnes in 2003 but by 2013 it had more than doubled, estimates ICIS Consulting.

But what if the consensus on China’ invulnerability is wrong?

Sharma cited recent studies that had analysed the “credit gap”, or the increase in private sector debt as a proportion of economic output, as a pointer towards economic problems.

“Looking back over the past 50 years and focusing on the most extreme credit booms - the top 0.5% - turns up 33 cases, with a minimum credit gap of 42 percentage points,” he added.

Among these 33 nations, 22 had ended up facing credit crises.

“Today, China’s credit gap continues to grow and it is now the largest ever recorded in the emerging world, having risen since 2009 by 71 percentage points, taking the total credit burden up to 230% of GDP,” he added.

“Before China, the five worst credit binges had come in Thailand, Malaysia, Chile, Zimbabwe and Latvia, all of which saw the credit gap grow by 60 points or more. All five suffered a severe credit crisis and a major economic slowdown.”

This suggests that even if China moves away from major economic rebalancing over the next few years, growth might still be a lot lower than many people expect. In other words, Beijing has lost its ability to control events.

Richard Iley, Chief Asia Economist for BNP Paribas, added in a late January research note: “Frequently unfinished real estate developments and white elephant infrastructure projects [in China] have seen the credit efficiency of growth plunge, while serial overcapacity in basic industries has led to ingrained industrial deflation.

“PPI [producer price index] inflation has now been negative for 22 months, with the latest survey suggesting that deflationary pressure is re-intensifying.”

Iley added that:

  • Debt service obligations were rising to an unsustainable level because of excessive borrowing and the slowdown in GDP growth.
  • Despite what he said was a “barrage of media headlines”, there was little, if any, evidence of rebalancing towards more consumption-driven growth.
  • As a result, the Chinese economy appeared to have suffering from the worst of two worlds over the last two years: slower growth and more extreme investment dependence.

He agreed with Sharma when he wrote: “The self-limiting argument is that, because the Chinese authorities have been able to exert an impressive degree of control over cyclical volatility for many years, this will necessarily continue to be the case. This argument manages to conflate bad economics, poor history and unsound logic.

“The key lesson from the global financial crisis was that long periods of stability sow the seeds for bouts of future instability.”

Chinese authorities did retain considerable ammunition – such as high reserve requirements and a strong central government balance sheet – to ride out the problems, he said.

But the economist warned that the “rising financial fragility of the economy, its still-widening imbalances and its fading ability to generate strong cash-flow growth all suggest that the degree of macro ‘control’ seen in the past will be increasingly hard to maintain.”

If Sharma and Iley are right, what might this mean for GDP growth? Growth could fall to just 4-5% over the next five years, said Sharma.

Growth at these much-reduced levels would still be very good because, as we have said, petrochemicals consumption is so much greater than a decade ago.

But who would be the winners and losers in such an environment?

By John Richardson