Deep understanding of inland China essential for tracking 2019 slowdown

Business, China, Company Strategy, Economics, Environment, Olefins, Polyolefins

By John Richardson

CHEMICALS companies are at great risk of getting Chinese demand very badly wrong in 2019 if they rely too heavily on flawed government data.

This article from the South China Morning Post is another example of the long-standing practice of official data underestimating economic weakness when a downturn is taking place. The newspaper reports that whilst 2018 industrial profit growth has increased in percentage terms, it has fallen when measured in yuan.

It is equally important not to only take headline national statistics, reliable or otherwise, as the basis for assessing growth in 2019. A deep regional focus will also be essential in order to get a real grip on the extent of the downturn in the Chinese economy.

There are three reasons for the slowdown: A steep fall in the availability of credit, the trade war and the pollution clean-up.

This excellent article from Reuters is an example of the level of local detail needed. It involved journalists visiting the central Chinese city of Pingdingshan in Henan province for the purpose of gauging the fall in consumer spending, with a particular focus on the drop in auto sales.

The big collapse in lending

At a nationwide level, China, which is the world’s largest auto market, might be about to see its first full-year drop in car sales for two decades.

Auto sales fell for three months in a row up until October with November auto sales set to be released fairly soon. There is a very close link between the availability of lending and the strength of auto sales.

The Reuters article makes two important points.

Firstly, it underlines how easy credit conditions have allowed hundreds of millions of Chinese to spend way beyond their incomes.

Cao Jun, a 40-year-old engineer and resident of Pingdingshan, who was interviewed by Reuters, earns $864.40 a month. This places him on an annualised basis $1,537 above the average per capita nationwide income level in 2017 – $8,836, according to the IMF.

But his income is still very low by Western standards and he faces heavy medical and home loan costs, as is the case with many other people in China.

He has been unable to buy a new car in 2018 because financing has become much harder to come by as a result of the big decline in credit availability. Nationwide speculative shadow lending was down by $698bn year-on-year in January-October 2018. Total social financing, which is lending via the shadow and state-owned banks, was $246bn lower.

Despite recent financial easing measures, credit on a net basis will be lower this year than in 2017. This is set to continue in 2019 as China lacks the financial firepower to repeat economic stimulus on the scale of 2009-2017.

It was the unprecedented scale of stimulus after the Global Financial Crisis that led to China’s extraordinary growth in consumer spending and so chemicals and polymers demand. People borrowed to spend and enjoyed strong growth in personal wealth as they made money out of the real-estate bubble.

The second important point made by Reuters is the impact of the environmental clean-up on economic activity in Pingdingshan.

China’s leaders have long recognised that China cannot afford the human and economic costs of today’s levels of air, water and soil pollution. Whilst in some northern cities air pollution standards have been relaxed during the winter months to support economic growth, the overall direction remains unchanged.

Reduced availability of lending and attempts to shift away from coal as a fuel source help to explain why auto sales in Henan province dropped 25% in September and 18% in October. This compares with a 12% October fall in nationwide auto sales.  The province is heavily dependent on coal for its economic growth.

Pingdingshan has been badly affected by lower operating rates at the state-owned coal and chemicals producer, Pingmei Shenma Group. Lower operating rates, the result of attempts to improve air quality, have led to wage cuts and weaker spending in shops and restaurants.

The trade war, as Reuters again reports, is another factor behind slower economic growth in the provincial city. Consumers have become more cautious in their spending as they worry about the trade war, with US tariffs on Chinese exports beginning to have an effect.

Less is more versus catch-up growth

It in the inland cities, towns and villages where the greatest potential for future growth in consumer spending lies because of much lower wealth and income levels than in eastern and southern China.

This is reflected in major regional variations in per capita chemicals and polymers consumption because, of course, chemicals and polymers go into such a wide array of finished goods.

The above chart, which uses PP as an example because of its heavy use in autos production,updates the potential for future demand growth in inland China:

  • Henan’s per capita PP consumption was 14.8 kilograms in 2017, below the national average of 18.7 kilograms.
  • This compared with Beijing at 42.2 kilograms and Shanghai at 41.2 kilograms. In richer provinces, less is more will be the priority as the focus switches to sustainability.
  • But in Henan etc. it is still a case of catch-up growth as incomes rise. 500m Chinese live on less than $5.50 a day, according to the World Bank, with the majority of these people living away from the coast.

The problem for the global chemicals industry is its extreme over-reliance on China as a source of consumption growth.

Take PE as another example. Between 2018 and 2025, China will account for 36% of global consumption growth with the Asia & Pacific region in second place at 27%, according to the ICIS Supply & Demand Database.

And in terms of actual tonnes of growth, as the above slide illustrates which details all the major cracker derivatives, China will lead the world in 2018-2025.

Because China is the most important market in the world and because the greatest potential lies inland, the focus has to be on better understanding inland growth. Senior executives need to familiarise themselves with provinces and other administrative regions that they may have never even heard of.

Local sales offices or representative offices will help, provided they are staffed by good quality people who can pick up anecdotal evidence on what is happening in the smaller provincial cities and towns. There is no substitute for wearing out shoe leather in constantly talking to people on the reality of economic conditions, as the Reuters article so clearly illustrates.

Just as important for chemicals companies is to take all official data with a very large pinch of salt.  That’s if they want to avoid repeated profit warnings in 2019.

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