Market outlook: Be careful what you wish for from China

Continued strong growth in China’s exports wouldn’t mean a global recovery, but would instead mean that China was exporting deflation

Be very careful what you wish for in China right now. A good example was the unexpectedly strong growth in the country’s overall exports in September, which led some analysts to conclude that Western economies were enjoying strong economic recoveries.

China’s overall export growth could be an ominous sign of slow domestic demand Copyright: Rex Features

Exports grew by 15.3% in September on a year-on-year basis, considerably better than the 12% that had been forecast by several economists. This followed a strong rise in exports in both August and July.

“But at what price? I am worried that China is busy exporting deflation at the moment because of its huge overcapacity in so many manufacturing sectors,” said a Hong Kong-based metals analyst.

He was mainly referring to the China customs announcement that steel imports rose in September by 73% to a record volume high of 8.52m tonnes.

This extraordinary increase was widely attributed to local steelmakers attempting to export their way out of growing debt and domestic oversupply problems, as real estate construction slows down.

Steel prices in China had fallen by around 17% in 2014, with European prices down by 13%, according to a 21 October article in the Financial Times. This was blamed on both oversupply in the Chinese steel sector and the steep decline in raw material iron ore prices.

BIG EXPORT VOLUMES FOR PVC, PTA
China’s overall factory gate prices fell by 1.8% in September, according to official data. This was the 31st consecutive month that producer prices had fallen.

What applies to steel, and to China’s manufacturing sector as whole, also applies to several chemicals and polymers, with the data on polyvinyl chloride (PVC) and purified terepththalic (PTA) especially shocking.

“As recently as 2009, when its stimulus programme began, China was the world’s largest importer of PVC,” wrote Paul Hodges, chairman of UK-based chemicals consultancy, International e-chem, in a 28 October blog post .

“Its net imports then totalled nearly 1.5 million tonnes, coming mainly from Asia and the US. But since then it has been busy expanding its own production,” added Hodges in the post on his ICIS blog, Chemicals & The Economy.

“By 2012, China’s domestic output had jumped 70% from 9m tonnes to 15.25m tonnes. As a result of this, and the start of the housing market slowdown, its imports had halved to 665,000,” he said.

And in January-September 2014, China stopped being a net importer of PVC as imports during that period were just 608,000 tonnes compared with exports of 949,000 tonnes.

“Global PVC prices have been weakening over the past few months on lots of factors, including, very importantly, I think weaker construction activity in China. This has contributed to the rise in China’s exports,” said a Singapore-located polymers trader.

WAVE OF PTA CAPACITY
PTA pricing has also fallen on weaker crude (as is also the case with PVC, of course) and the huge build-up in local PTA capacity in China. This capacity has been brought onstream during a year when demand growth has been much weaker than just about anybody expected.

“We are shocked, quite frankly. Yes, we’ve obviously known about the big wave of new capacities in China for years now, and that 2013 and 2014 would be difficult years on the supply side. But what we didn’t expect at all was the extent of the demand weakness,” said a source with an Asian PTA producer.

NO LEVEL PLAYING FIELD
All of this bad news is, not surprisingly, reflected in PTA trade flows.

China customs data, based on analysis by the US-based trade data service Global Trade Information Services, reveals that:

■ China imported 6.5m tonnes of PTA as recently as 2011, but this had fallen to just 2.76m tonnes in 2013.

■ In January-September 2014, import volumes more than halved to less than 1m tonnes, compared with the same period last year.

■ China has also begun exporting PTA for the first time in its history, with 340,000 tonnes sent overseas in the year to September.

■ If these trends were to continue, China would end up as a net PTA exporter by around this time next year.

And the problem for the global chemicals industry isn’t just confined to products where China is already in surplus, such as PVC and PTA.

CHINA STOCKING UP ON PE?
In the case of polyethylene (PE), for example, imports grew by 9% year-on-year in January-September 2014 to 6.96m tonnes, according to China Customs. This is despite persistent market intelligence pointing to weaker demand growth and a 9.5% increase in domestic production, during the same period, to 9.5m tonnes.

“I think this points to the possibility that China has been stocking up on resin, not to meet domestic demand, but to instead export more finished plastic films,” said a business development manager with a global polyolefins producer.

“Even if this proves not to have been an issue this year, I think it could well be a problem in the future,” he added.

“And so, if you are a low-cost provider of PE to China, such as the US, China will be delighted to take material off your hands. The only trouble is that this resin will end up returning to the US in the form of plastic films, and so damage sales of PE manufactured locally,” continued the business development manager.

“Of course, there is another outcome here as the US adds a lot more PE capacity over the next few years. This would be higher trade barriers, such as anti-dumping duties, designed to protect local converters from low cost Chinese competition.

“But the danger is that China might respond by erecting its own trade barriers against imports of US resin. Where, then, would the US place its production surpluses?”

A much more benign view of China’s recent surge in direct chemicals and polymers exports, and perhaps re-exports of PE in the form of plastic films, is that this is only a temporary dislocation in global markets.

This view might turn out to be right if China’s domestic economy enjoys a swift rebound in growth during 2015.

At least for the first half of next year, however, the view of most economists is that there will be a further slowdown in China’s GDP growth. Even more worryingly, since July, a growing number of economists and other observers have started to wonder whether China’s annualised GDP growth might fall to 4%, or even lower, over the long term.

If the economic playing field was truly level, lower local growth would result in the closure of uncompetitive chemicals, polymers and downstream capacity in China.

But what if China keeps most of its chemicals and polymers plants open, along with the majority of its downstream capacity, in order to protect jobs?

Maintaining employment at levels sufficient to prevent major social unrest has long been one of the government’s top priorities.

In the case of PTA, also, many of the plants are brand new and world-scale, said several polyester industry sources. This might result in China running these plants at very high operating rates, in an attempt to force older, and therefore less competitive, South Korean, Thai and Taiwanese plants to shut down, they added.

Instead of wishing for China’s export growth to remain strong, it might therefore be worth wishing for a decline in its exports. Such a decline could indicate that domestic manufacturers are enjoying a recovery in local demand.