Nobody has a clue about the true nature and full extent of the interconnections between China’s property sector and polyolefins demand.
This was one of the key themes to emerge from the Asia Petrochemical Industry Conference (APIC) in Pattaya, Thailand.
Take the links between biaxially oriented polypropylene (BOPP) film production in China and property. One theory is that speculators had moved into producing BOPP finished film in order to get their hands on cash flows to service property deals. This had driven the sector into serious oversupply.
The converters were losing some yuan (CNY) 1,000 ($160) for every tonne of BOPP film, but this was of no matter as the revenue they earned had provided enough cash to complete real estate developments, said some polyolefins industry sources.
Why did this happen?
Because government restrictions on bank loans for property development, which were introduced two years ago, forced investors to look elsewhere for their financing.
Elsewhere was often overseas where, thanks to the US Federal Reserve’s quantitative easing (QE) programme, interest rates have been exceptionally low for the past five years.
Money borrowed overseas was moved onshore to build the BOPP film lines. One source noted that the actual land on which the new BOPP plants were built upon was the real target behind the investments.
“I’ve heard a different version of this story. The converters haven’t invested in the real estate sector but have instead set up their film lines so that they can sit on the land that their factories occupy, in the hope that the land will appreciate in value,” said a delegate at APIC.
“BOPP film lines tend to take up a lot of land, which is why this particular product was chosen,” added the delegate, who is a senior executive with a major Asian polyolefins producer.
Whether production of other grades of polyolefins – and other chemicals and polymers – has been similarly distorted remains unclear because of the opacity of China’s markets.
An equal lack of understanding surrounds why China’s polyethylene (PE) imports surged by 26% in the first quarter of this year over the same period in 2013, even though just about everyone has said that demand was very weak.
What further baffled delegates was that the steep rise in imports occurred as domestic production rose by 8%.
The story behind the imports might end up bearing a strong resemblance to the explanation for oversupply in BOPP film grade. Financing for the imports might again have been obtained via cheap overseas loans, with completion of property deals the real, final purpose behind the shipments. This is how the mechanism could have worked:
A potential lender buys a PE cargo on normal 180 days credit from an overseas seller.
He then immediately sells the cargo on the Dalian linear-low density PE (LLDPE) futures market, or into the physical market.
Now he has cash to lend into the shadow banking market at interest rates of 60%.
This gives a property developer cash to finish his project, which is no longer available via formal bank lending because of the government’s crackdown on credit.
“If PE has been imported for this reason then some of it may be still sitting in warehouses, in the hands of traders. At some point it will have to find its way into the physical market where it could cause some major problems,” said a second APIC delegate, who works for a US-based global polyolefins producer.
PP imports on the rise
Delegates were also scratching their heads over why polypropylene (PP) imports rose by 10.5% in the first quarter over the same period in 2013 when, again, demand seemed to be very weak. But the APIC delegates were clear about one thing: China’s economy is decelerating by more than they had expected because of broad-based, determined, sweeping economic reforms.
“The reforms are more extensive than I predicted and are affecting not just the speculators, but just about everyone. We have no idea how this is going to end,” said a chemicals trader, who also attended APIC.
Particular concern was focused on how the property sector was being affected by reforms, given that it was responsible for around 16% of GDP in 2013, according to investment bank Nomura.
“The weak sentiment in chemicals and polymers markets in general is mostly about what is happening in real estate,” said a Hong Kong-based chemicals analyst. “Until or unless the government arrests the slide in property, sentiment will remain weak.”
Property sales declined by 5.2%, new construction fell by 25% and unsold completed properties rose 23% year-on-year in Q1 2014, said the National Bureau of Statistics.
And in April, home-price inflation declined to its lowest level in a year and a half, according to an official government estimate.
There was a theory doing the rounds at APIC that measures taken by several local governments to prop up real estate sales might arrest the slide.
However, an editorial, which appeared in the China Daily recently, suggested that this real estate downturn is more serious than that which occurred in 2008.
In 2008, the decline in the market was psychological, but on this occasion it was the result of a “real purchasing power crunch,” wrote the government-run China Daily.
House prices have risen ten-fold in the past decade in major cities and were thus too expensive for ordinary wage earners, continued the newspaper.
It also pointed to major oversupply of properties in some cities.
Local government measures would, as a result, be insufficient to prevent what was likely to be a “substantial correction” in real estate, warned the China Daily.
Beijing could come to the rescue by launching another big economic stimulus programme.
But the China Daily editorial, underlining recent comments made by China’s president, appeared to rule out any such policy U-turn. And so, in the absence of a change of heart by Beijing, what would a “substantial correction” in real estate might mean for the overall economy?
Every six percentage point decline in real estate investment translates to a one percentage point dip in GDP, according to Nomura.