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The global credit crisis is going to last

Aromatics, Business, China, Economics, Fibre Intermediates, India, Middle East, Olefins, Polyolefins, Projects, Singapore, Styrenics, Thailand
By John Richardson on 20-Aug-2007

The collective sigh of relief was almost audible late last week when the Fed cut its discount rate – the rate banks charge each other for lending.

Action from other central banks, including the European Central Bank, could follow this week. Analysts also rate the likelihood of the Fed cutting its formal interest rate at its meeting next month at 50 per cent or more. This is the rate charged to companies and other non-bank borrowers.

But still, this credit crisis is not going to away that easily. See more detailed analysis below, but in short here, the implications could be:

*A weaker Chinese economy. Roughly one-third of China’s GDP is dependent on exports and if the US goes into recession, this is serious. Many overseas chemical projects have been justified by estimates of persistently strong demand from China for imported chemicals that will be re-exported as finished goods. Sales of locally made chemicals would, of course, also suffer

*Unfunded projects backed by smaller private companies being shelved.

But a lot of capacity in the Middle East and China is too far advanced to be cancelled. In the Middle East, many of the projects already under construction might come on stream bang on time because the producers there can make money in any market conditions. Projects under construction in China start up on schedule because the government wants to gain greater independence from imports.

Let’s hope this crisis goes away, but if it doesn’t why on earth didn’t the supposedly smart people who run the global financial system realise the dangers? Joseph Stiglitz, a genuinely smart guy, has been warning for years about the risks, which he outlines in this excellent article

The Federal Reserve’s decision to cut the discount rate late last week does not necessarily mean that the credit crisis is over.

Even if more action is taken by the Fed, the European Central Bank and other lenders the crisis is not going to go away overnight, meaning the implications for chemicals demand could be serious.

In the US housing starts fell in July, down 6% from June and 21% from July 2006. The Manufacturers Alliance predicted last week that GDP (gross domestic product) would grow by just 1.9% this year, down from its May forecast of 2.3%.

The dreaded “R” word is a distinct possibility because the full ramifications of the sub-prime mortgage-triggered crisis have yet to become clear.

But will they ever become clear? The supposedly intelligent people who run the global financial system have no idea about the value of the complex secondary debt instruments that they have bought and sold in abundance.

And so panic alone might be enough to send economies across the world into tailspin if investors assume the worst and continue to sell shares.

More seriously, banks might remain reluctant to lend to one another. Even solvent banks could come under pressure as liquidity dries up; and, of course, companies will find it very difficult to raise funds.

Two-thirds of US growth since the 2001 recession has been the result of the booming housing market, according to some estimates. The market has been fuelled by what now seems the insanity of lending a truck driver earning $30,000 a year $500,000 for a home at zero or even negative interest rates.

The virtuous circle of rising property prices and strong consumer spending has been broken.

Falling real-estate values and weaker high street sales are not just bad news for the US economy.

Asia is less reliant on US growth thanks to the doubling of average net incomes in China and India since 2001 and big rises in consumption in other emerging economies.

But roughly one-third of China’s GDP (gross domestic product) is derived from exports, a big slice of which are still shipped to the States.

A US recession would hurt local chemical sales and the shipments to China that are re-exported as finished goods.

Singapore is adding at least cracker one complex by 2011, possibly two, on the assumption that China’s appetite for imports will remain strong. The tiny island state has a very small local chemicals market.

Thailand is adding two more cracker complexes by 2010 to mainly serve its bigger domestic market. But significant exports are inevitable, at least in the short term, as local consumption catches up with supply.

The bigger danger is that banking systems and economies across the world could be damaged, thereby driving down local chemical sales for local consumption.

In Singapore, property prices have soared since late 2006 with Indian real-estate values as much as tripling over the last few years.

These property booms have again been fuelled by easy credit terms that will surely no longer be available.

Consumer confidence would be hurt by tighter credit conditions and weaker stock markets.

Will this be as bad as 1997? Hopefully not as Asian government have huge foreign-exchange reserves that can be used to pump-prime economies, along with whatever further action the Fed and other central banks decide to take.

As for the next chemicals downturn, which is expected in 2009, the assumption before the credit crunch was that it would not be as deep and as long lasting as in 2001.

The reasons given were strong global growth and the exit of high cost naphtha-based producers in the US, Europe and Asia.

The average age of crackers in the US is 28 years, meaning that many are fully depreciated.

Maintenance costs are higher than in 2001 and environmental clean-up costs lower, which also point to more rationalisation.

Lower global growth could hasten and add to the volume of scrapped capacity.

It is too early to say whether project delays and cancellations might also ease conditions.

The bulk of the Middle East new capacity, despite labour, equipment and raw material shortages, is due to start up more or less on time because funding has been secured and construction has started.

Even if market conditions deteriorate, these plants might still start up on schedule because they have such a big competitive advantage.

But the smaller private companies yet to secure funding may struggle to get the money they need for their projects.

The cracker projects in Iran beyond Olefins No 10 were out of the equation before the credit crisis because of politics.

The Chinese are committed to import substitution and have no shortages of labour, equipment, raw materials or money. All the crackers under the current Five-Year Plan (2006-10) are therefore likely to start up on time.

The unanswered question is what will happen to the timing of projects under the next Five-Year Plan, which officials began to draw up earlier this year.

And so it is far too early to make predictions on the downturn.

But as one industry observer said recently: “It is not too early to be preparing for the worst by making cost savings. If I were a CEO in a company in any sector I’d be thinking ‘Do I tell 15% of my workforce not to bother coming back to work after their summer holidays?’ ’’.

Redundancies on this scale – along with all the people caught on the wrong side of tighter credit conditions and real estate and stock market collapses – would mean a great deal of lost chemicals demand.