By John Richardson
NOBODY involved in the Asian chemicals industry is likely to have been surprised by Saturday’s announcement that January’s official purchasing managers’ index (PMI) slipped into negative territory for the first time in more than two years.
The reason is that many people involved in the business have seen disappointing sales volumes in China during January.
In late December, though, many of my contacts were of a very different view about how January would turn out.
They were confident of a strong sales recovery during the first two weeks of the month ahead of the traditional pre-Lunar New Year slowdown, which will begin in around a week’s time.
Explanations given for the disappointing January include:
- Customers holding-off from purchases because of a lack of credit and an aversion to risk resulting from worries about the overall economy.
- Further declines in oil prices – the other big factor behind customers maintaining their “hand to mouth” buying patterns.
What concerns me is that the majority of people I speak to still think they were right, but that they were just off by a month in their forecasts of a strong recovery.
Arguments supporting this notion include widespread reports of low inventory levels held by chemicals and polymers buyers down several of the product chains.
And, as I discussed last Friday, in the polyolefins business there is a strong belief in the resilience of “underlying demand growth” in China.
But please take advantage of the Lunar New Year lull in sales activity to do some hard thinking.
Print off my post from last Friday, discuss it amongst your colleagues, and ask yourself this very difficult question: What will underlying demand growth be as the New Normal further develops in China during 2015?
A “business as usual” approach to corporate planning will, I think, get you into an awful lot of trouble.
More evidence to this effect is emerging by the day.
The majority of economists now accept that the New Normal is a reality. The trouble is that their fresh analysis has arrived 14 months too late.
The unsustainable build-up of debt remains the focus of a lot of this new thinking.
For example, in this FT Alphaville blog post from yesterday, analysts were reported as saying that:
- Since 2008, debts owed by China’s non-financial sector have soared by more than 90% percentage points relative to GDP.
- Chinese corporations are, as result, amongst the most indebted in the world. To give you a sense of perspective, it took Japanese non-financial businesses ten years to increase their indebtedness by 30 percentage points of GDP during the 1980s.
- Seventy percent of the increase in debt since 2008 has resulted from borrowing by big state-owned institutions. Thirty per cent of that debt is owed by companies in real estate, construction and engineering. Another 16% is owed by companies in oil, gas and chemicals (see the chart below).
“Until the banks — which themselves are creatures of the state — start making loans on the basis of profitability and creditworthiness rather than political considerations, the household sector will continue to see its modest savings misdirected into dubious projects,” concluded the FT Alphaville post.
This process of better allocating new lending began in November 2013 – as did starving “bad businesses” of working capital.
True, vested interests in the state-owned enterprises will continue to offer stiff resistance, but individuals need to watch their step as the clampdown on corruption continues.
And the “iron will” of China’s government to complete this painful reform process was further underlined in comments made by Li Keqiang, the country’s Prime Minister, during a meeting with local business leaders on 26 January of this year.
How bad will it get before it gets better? Here are some worrying observations and statistics from this Financial Times article:
- Despite last year’s slowdown, total investment in the real estate sector still increased 10.5% for the year and unsold floor space was up by more than 26%, according to official figures.
- The data therefore suggests the correction in China’s real estate sector has not even really begun (see the third chart below). When the sector starts to contract, which could be as early as this year, the headline growth rate could fall much faster and the country might well face a wave of bankruptcies — as well as a possible debt crisis, economists warn. When ancillary industries are taken into account, real estate construction makes up about a quarter of China’s $10 trillion economy.
- Prices of commodities, such as iron ore and copper — key ingredients in any construction boom, are trading close to levels last seen in the midst of the global financial crisis, and that is before the Chinese construction correction has even properly happened [Ask yourself this further question: Why shouldn’t chemicals react in the same way?]
- A slowdown in local government spending has also yet to really begin. For example, partial statistics on local government fundraising shows they sold Rmb1.66 trillion worth of bonds in 2014, compared with Rmb900 billion in each of the two previous years.
- The FT also quoted a new Deutsche Bank report as saying the following: “In 2015, China will probably face the worst fiscal challenge since 1981 [before growth accelerated]. We believe the fiscal slide [the fall in revenues] is the top risk for the Chinese economy.”