By John Richardson
CHINA’S decision to make more funds available to lenders in order to ease the credit crunch does not represent a long-term change in policy direction, we think.
“The worst is over. The People’s Bank of China (PBOC) is likely to serve as a [lender of] last resort and intervene to calm the markets and avoid such huge volatility,” Chen Qi, a Shanghai-based strategist at UBS Securities Co told Bloombeg.
“Although a reduction in interest rates or [bank] reserve [requirement] ratios is not likely in order to avoid confusing policy signals, we do think reverse repos are very likely to be resumed and the PBOC will use window guidance as well. We expect liquidity tightness to persist.”
But the problem for the petrochemicals business is that in the absence of interest rate cuts, lower reserve requirement ratios for the big banks and/or a new economic stimulus programme, there will be no return to the speculative frenzy that gave so much support to growth rates.
Polyethylene (PE) demand growth, for instance, surged to way above the increase in overall GDP (see the above chart) in 2009, during Beijing’s huge economic stimulus programme.
An army of speculators entered the business during that period, some of whom rang up traders in Singapore and said: “I want to buy resin, I don’t care what grade it is, just send me whatever you have.”
Up until February, while most people recognised that there would be no return to the heady days of 2009, the consensus view was that China would still be prepared to pump money into the economy in order to support growth.
But since then most petrochemicals markets in China have performed badly because of a sharp decline in speculative activity, according to our colleagues at CBI China.
“Traders are either still sitting on high stocks and, therefore, are not buying anything or are busy liquidating inventories,” a Hong Kong-based aromatics trader told the blog.
In the case of the PE, traders appear to have built inventories as recently as May-June on the false expectation of easier lending conditions.
And, without interest-rate cuts lower reserve requirements and/or economic stimulus, the outlook for China’s manufacturing sector also appears to be bleak. It is, of course, the slowdown in the manufacturing sector that is the other big factor behind lower growth prospects. As we have said many times before, the economic adjustment process will be painful and could take many years to complete.
Continued liquidity tightness, will according to Nomura, lead to “painful deleveraging process in the next few months.
“Some defaults will likely occur in the manufacturing industry and in non-bank financial institutions.
“In particular, we see risks in local government financing vehicles, trust companies, property developers, credit guarantee companies, and leveraged manufacturers in industries with over-capacity problems. The non-performing loan ratio will likely rise, and we expect GDP growth to trend down to 7.2% y-o-y in Q4.
Nomura adds that there is a 30% chance that GDP growth will fall below 7% for the full-year 2013, writes Augistino Fontevecchia in this Forbes in this article.
“The risk for policy makers is that financial stress and slowing growth are mutually reinforcing,” says the Wall Street Journal’s Tom Orlick in this article.
“Deteriorating conditions in China’s manufacturing sector mean factories have more difficulty servicing loans, adding to pressure on banks’ asset quality. Slower lending growth and higher prices for credit add to the squeeze on businesses, further denting profitability and repayment capacity.”
The disappointing HSBC/Markit June flash purchasing managers index for China is evidence of how tighter lending conditions are already hurting the manufacturing sector. The index fell to a nine-month low, largely we think because total social financing fell from $410bn in March to $200bn in May, according to a Nomura estimate.
(Total social financing is the complete credit picture in China, representing new lending by both the state-owned banks and the shadow-banking system. China’s anxiety over the shadow-banking system is the main driver behind the tighter financing environment.)
But, despite the risks of a more severe slowdown, it is worth a reminder as to why China has no real choice but to stick to its current policies.
“If the authorities decide to go for growth and engineer another stimulus, inflation is likely to rear its ugly head very quickly,” says Diana Choyleva of Lombard Street Research, the macro-economic forecasters, in this Beyondbrics blog post.
“The global financial crisis marked the end of the road for China’s export-led growth model.
“Unless there are structural reforms, just throwing money at the economy will produce inflation and bubbles rather than sustainable growth as happened after Beijing’s gigantic post-2008 stimulus.”