Market outlook: Multiple scenarios for China growth

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Even if China avoids a real-estate led crisis, the country must move its economy from an investment to a consumption-led growth model

Just a few years ago, it did not really matter if you only had one scenario for growth in any chemicals or polymer market in China.

If your growth forecasts for China were a little optimistic over, say, a two-year period, this did not matter at all because over the longer term, the economy was so robust that you would quickly recover lost ground.

And quite often the reverse happened, with growth being better than you anticipated. As every mid-level petrochemicals company executive knows, it is better to under-promise and over-deliver to your board of directors than the other way around.

Now, though, there are no guarantees that China can firstly avoid a real estate-led financial crisis.

Even if it does avoid such a crisis, it faces the challenge of successfully moving its economy from an investment to a consumption-led growth model.

“I think China’s old investment-led economic growth model is running out of steam, and whether or not it can make the transition to consumer-led growth is very much in the balance,” said a Hong Kong-based investment banker.

“If anyone tells you not to be worried – that the only way is up – I believe they are being intellectually dishonest. The honest answer is that nobody knows whether or not China will be able to tackle its current problems. This means you need multiple scenarios for growth in any manufacturing or service sector,” he added.

CREDIT-DRIVEN CONSUMPTION LEAP

Let’s think this through just for one product – high-density polyethylene (HDPE). HDPE’s wide range of end-use applications includes the humble supermarket shopping bag – where the value addition is very low – all the way up to extremely high value plastic pipes that transport natural gas.

The ICIS Supply & Demand database shows just how fantastically strong HDPE demand growth has been in China, particularly since 2008:

■ In 2008, consumption was around 5.5m tonnes, but by the end of 2013 it had grown to approximately 10m tonnes – an increase of no less than 81%.

■ This was almost double the 41% increase during the five years from 2003 until 2008.

What made 2008-2013 so incredibly good for HDPE – and for many other chemicals and polymers – was the big growth in credit during the 2009-2013 economic stimulus programme.

In the case of HDPE, government spending on infrastructure resulted in strong growth in demand for natural gas pipes, with the boom in the property sector benefiting consumption of kitchen containers and utensils made from HDPE.

China increased lending by no less than $10tr in 2009 alone, when its nominal GDP was only $5tr, with the lending binge continuing until the end of 2013.

There was then a sharp dip in lending growth from early 2014 until the end of 2015, but credit growth picked up again in the first half of this year.

Still, ICIS Analytics & Consulting expects HDPE demand will have risen by a comparatively modest 21% in the five years from 2013 and 2017 – and again by 21% in the five years from 2017 until 2021.

This would be the result of a slower, but more sustainable expansion in GDP as overinvestment in real estate and industrial capacity is reduced.

Volume-wise, however, the Chinese market is much bigger than it was back in 2003. This means that even with a lower percentage growth rate over the next few years, the rise in consumption in terms of extra tonnes would still be big. In 2021, demand is expected to total 14.5m tonnes versus 12m tonnes in 2017.

These forecasts for HDPE growth are only one scenario, and, as we said, one scenario no longer works in today’s China. So what might lead to demand growth being lower than we expect?

THE ULTIMATE PROPERTY BUBBLE

Research analyst Harry Dent quoted the following HSBC data in a 14 October article he wrote for the investment website Seeking Alpha:

■ China’s total value of residential housing is 3.27 times GDP, and is forecast to hit 3.72 times by year-end.

■ Japan’s great bubble peaked in 1990 at 3.7 times GDP. Shortly after, property prices fell through the floor, losing 67%.

■ Hong Kong’s 1997 bubble peak was at 3.04 times.

■ The US bubble peak in early 2006 was at 1.75 times.

■ Hong Kong’s current bubble has left the value of residential housing at 5 times GDP. This is expected to rise to 5.5m times by the end of this year.

The fact that Chinese real estate is less frothy than Hong Kong’s is no source of comfort, given that China’s total debt is now at 250% of GDP compared with 150% of GDP in 2008, according to the Bank for International Settlements (BIS).

Other alarming data points include a 66% increase in land values in China’s top 100 cities over the past 12 months, according to Deutsche Bank. It adds that two-fifths of property developers which have made winning bids for land over the last year will lose out, even if cost increases merely level out, never mind decline.

Then there are the many thousands of Chinese families who have used their collective savings to go long in real estate over the last 12 months. One-fifth of buyers are estimated to be investors rather than owner occupiers. The negative wealth effect would be significant if property prices merely stopped rising at today’s heady pace.

What could cause the new real estate bubble to pop? That quite scary number from the BIS. Few countries with this degree of leverage have in the past avoided a financial crisis. Real estate is at heart of this risk as total home loans are expected to be around 30% of GDP this year versus 20% in 2014.

Let’s say, though, that China once again proves the sceptics wrong by avoiding a real estate-led financial sector crisis. What are its chances of creating a new, more sustainable growth model?

UNLOCKING HIGH RATES OF SAVINGS

While China’s manufacturing sector is burdened by oversupply and high debt, the country’s personal savings levels are very high. Despite the boom in consumer spending over the last 20 years, there is still a propensity among many people to save rather than spend money.

The key to success is persuading people to consume even more. The government can achieve this by improving healthcare and pensions provisions. Organisation for Economic Cooperation and Development (OECD) data show the following:

■ China’s basic pension pays just 1% of average individual/province earnings for each year of coverage, subject to a minimum 15 years of contributions.

■ 30 years’ employment provides a pension of just 30% of this average wage.

■ Some employees also pay 8% of their wages into a retirement fund and receive top-up annuities based on individual savings – but this only covers 210m urban employees.

Until or unless the government can close this gap, Chinese families will want to save rather than spend money in order to cover their own retirement and healthcare costs.

One of the problems that Beijing faces is a rapidly ageing population, thanks to its One Child Policy.

Even though that policy has been abandoned, birth rates could take a generation to improve by enough to reverse the decline in the size of the working population. Fewer workers means lower tax revenue.

A solution is to transform the Chinese economy by moving up the manufacturing and services value chain. If China can, for example, become a producer of internationally recognised high-quality automobiles, then this will boost tax revenues.

It would also help justify the higher wages that have resulted from a shrinking working population.

Can China square the circle? Come back in 10 years and we will give the answer. That’s how long it will take before we know whether economic reforms have been successful.