China: There Are No Shortcuts To Recovery

Business, China, Company Strategy, Oil & Gas

BlackmondayBy John Richardson

STOCK markets can do what they want over the next few days and weeks. They will surely bounce around like crazy on every tiny detail of economic news from China. For example, yesterday there was a 3% recovery in London, a 4% rebound in Paris and Germany was up by 5% (but the US was still down by 1.3%). These recoveries were in response to China’s decision to cut interest rates again.

This is fine for equities. At times of extreme volatility like this, there will be a lot of money to be made and lost in day-to-day or week-by-week movements.

But chemicals companies must not under any circumstances take note of all this background noise – and in this background noise I include China equities. Yes, they are in an awful mess at the moment, but they too might rally.Again like Western stock markets, though, China’s exchanges do not reflect what’s happening in the real economy. In fact, in the case of China this is even more so because of the relatively small number of people in China who play on stocks.

There is, of course, one huge proviso to this: There is every chance that as oil, equity markets and as bond markets tank, and as margin calls are made on all those investors who are overextended, there will a familiar rush to the crowded exit. Because not everybody will be able to get through the door at the same time, you could well end up with a repeat of September 2008.

But let’s just hope this doesn’t happen and global equity markets settle down (although please note that I feel there is no way back for oil prices. They will continue to head back down to their long-term historic average price of $30 a barrel) .

In circumstances of calmer and stronger equity markets, what people in chemicals companies everywhere simply must do, what they simply have to do if they want to emerge out of the other end of this crisis intact, is to accept that no matter what the Chinese government does from hereon in, there are no shortcuts. No amount of temporary economic stimulus is going to stop the real economy from going through an incredibly painful and prolonged transition phase.

This is something that Paul Hodges and I have been warning about for three years, with the red warning signs flashing red, telling people to take action immediately, from November 2013. I just hope many chemicals companies listened back then and took appropriate action.

Any regular reader of this blog, or anyone who clicks through to the links above and reads them closely, will know this.

But for those who too busy dealing with inventory management and cash-flow issues, here is an extract from of an excellent article in the Financial Times last week that neatly describes China’s long-running dilemma:

Beijing has launched a huge programme that some describe as “quantitative easing with Chinese characteristics”, to swap short-term local government debt for longer-term, lower-cost bonds.

But even after this debt swap, local governments will have to make Rmb1tn ($156bn) in interest payments on their existing debt this year alone, according to estimates from JPMorgan.

Yet income from land sales, which had accounted for an average of 40 per cent of local government revenues, has plummeted in the past year. This means local governments are struggling just to service their growing debts and pay for basic public services, and are in no position to contribute to another stimulus programme such as the one in 2008.

“Local governments’ fiscal constraints were a key cause of the slowdown at the start of the year and have limited the effectiveness of growth stabilisation measures,” says Zhu Haibin, chief China economist at JPMorgan.

The central government has tried to encourage private investment in public infrastructure projects and has poured trillions of renminbi into huge national projects this year, such as rail and road networks, sewage treatment facilities and shantytown redevelopments.

But this has not been enough to offset falling investment in factories and apartment blocks. Last month, fixed asset investment across the country rose by its slowest pace in 15 years.

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