This Is No Way To Run Companies In The Future

Business, China, Company Strategy


By John Richardson

WHEN the history of 2015 is eventually written, there will no doubt be some petrochemicals industry executives who will say, “I simply didn’t see this coming”.

This will to some extent be disingenuous as for share price reasons it is better to stick with the consensus view even if you hold private doubts. The risk is that if you stand out as a naysayer when everyone else is arguing all is good, the value of your company’s equities versus your competitors will take a hammering.

Perhaps this explains why a number of CEOs kept insisting that the rise of China’s middle classes and increased urbanisation meant that there was absolutely nothing to worry about, even though all the warning signs in China have been flashing red since at least late 2013.

The failure to identify what is happening today might also be the result of poor analysis. I think that people too often looked at China’s very recent history – i.e. 2008-2013 – and reached the conclusion that demand growth in petrochemicals and consumer goods that we saw during those extraordinary five years would be pretty much sustained.

In the final analysis, though, when the history of 2015 is written, one conclusion should shine as brightly as the mid-day Sun: This is no way to run companies in the future.

As Ambrose Evans-Pritchard  wrote in the UK’s Daily Telegraph: “China is at mounting risk of a financial crisis this year as growth sputters and deflationary pressures trigger a wave of defaults, Bank of America has warned.

“The US lender told clients that a confluence of forces are coming together that threaten to chill the speculative mania on the Shanghai stock exchange and to expose the underlying fragility of China’s $26 trillion edifice of debt.”

In a summary of the Bank of America report, which is entitled “Deflation, Devaluation and Default”, Evans-Pritchard added that the most likely scenario for this year is a surge in bad debts as growth slows.

This is likely to be followed by a credit crunch in the shadow-banking sector [from which most chemicals buyers in China source their financing] and then a major recapitalisation of banks.

China spent 15% of its GDP to rescue lenders in late the 1990s, but the scale of the problem is much greater today, he added.

Most estimates were that loans had jumped by roughly 100% of GDP in the past five years. This was twice the pace of growth in Japan before the Nikkei bubble burst in the 1990s, and was also more than the increase in US debt ahead of the 2008 Lehman Bros crisis, said Evans-Pritchard,

China has now seen 34 months in a row of producer-price deflation (see the above chart).

A similarly deep deflation trough affected the country in the late 1990s. Despite the huge export boost that China enjoyed as a result of its accession to the World Trade Organisation in 2001, it took six years to get rid of deflation on that occasion, he added.

And I would argue that China also benefited hugely from the West’s Babyboomers, who in the early 2000s were pretty much at the peak of the earnings potential.

The end of investment-led growth and the ageing the Babyboomers suggest that China might well face a battle to rid itself of deflation even harder than in the late 1990s.

“One of the side-effects of falling inflation is to raise the real cost of borrowing,” added Evans-Pritchard, in the same article.

“The average one-year rate for companies has spiked from zero to 5.50% in real terms since 2011. This amounts to drastic financial tightening, which the central bank has chosen not to offset, beyond a token 0.25% cut in borrowing rates.”

Bank of America  believes that when China’s economic growth further declines, and when the Fed raises interest rates, hot money outflows could lead to a devaluation of the Yuan.

As I flagged up last year, China would be quite happy to see the Yuan decline in value as this would enable to compensate for weaker growth at home by boosting its exports. In the process, though, China would, in effect, end up exporting its deflation to the rest of the world.

Something has to give on the Yuan as the currency’s real effective exchange rate, when you take into account rising labour costs, has risen by now less than 40% since 2008, according to Diana Choyleva from Lombard Street Research.


How To Get Through 2015 In One Piece (More Or Less)


By John Richardson EVERY time the oil price stabilises for just a few days there...

Learn more

Indonesia: Seize The Day


By John Richardson IT WAS criminally wrong. Yes, criminally wrong. Financial spe...

Learn more
More posts
Polyethylene producers must avoid repeating the mistakes of Q1

By John Richardson AFTER a very challenging first quarter, nobody wants to make further write-downs ...

China’s PP production growth could lead to big declines in 2020 imports

By John Richardson PLEASE DON’T say I didn’t warn you. China is rapidly moving towards polypropy...

Coronavirus, impact on the developing world and the scale of demand losses

By John Richardson ALL OF us are struggling to come to terms with a collapse in the global economy t...

Coronavirus, reshoring and the polyester industry: Good luck with that

By John Richardson POLITICIANS, not just including the Populist variety, are talking a lot about res...

Beware of the fragile nature of the oil and petrochemical price recovery

By John Richardson RECENT rises in oil and petrochemicals prices should not in my view be taken as a...

China petrochemical inventories build on what could be false hopes of a V-shaped rebound

By John Richardson AS PETROCHEMICALS storage space in China fills up on the hope that the country ca...

Further polyethylene rate cuts seem inevitable with no certainty on who will blink first

By John Richardson IT IS NOT just a razor-like focus on petrochemicals demand that will get you thro...

What petrochemical companies must do to adapt to a smaller coronavirus economy

By John Richardson PETROCHEMICAL companies can adapt to the coronavirus New Normal by running their ...


Market Intelligence

ICIS provides market intelligence that help businesses in the energy, petrochemical and fertilizer industries.

Learn more


Across the globe, ICIS consultants provide detailed analysis and forecasting for the petrochemical, energy and fertilizer markets.

Learn more

Specialist Services

Find out more about how our specialist consulting services, events, conferences and training courses can help your teams.

Learn more

ICIS Insight

From our news service to our thought-leadership content, ICIS experts bring you the latest news and insight, when you need it.

Learn more