By John Richardson
DURING A VISIT to Shanghai in 2019, I was told that the waiting list for a table at one high-end Shanghai restaurant was eight months. No food can possibly taste that good.
There were also long queues outside the designer clothing and accessory shops, and I don’t think I’ve ever seen as many BMWs, Mercedes and even Ferraris on one street at the same time as I did in Shanghai during that trip.
On my first visit to Shanghai in 2000, the city was vastly, vastly different, with the traffic dominated by bicycles and the skyline largely condo-free.
First-hand impressions of China such as the above are so common that when economists such as Michael Pettis suggest that domestic demand in China remains weak compared with other parts of the economy, people often react by saying, “Don’t talk to nonsense”.
But it is not nonsense as no one impression or data point has any relevance without the wider context.
Pettis, a professor of finance at Guanghua School of Management at Peking University in Beijing, has long argued that China’s economy has become dangerously unbalanced because of excessive “supply- side” economic stimulus and not enough demand-side stimulus.
He believes that this supply-side focus, involving big spending on infrastructure, real estate and manufacturing, worked fine in the 1980s because it was urgently needed the capacity.
But he wrote, in a January 2022 Financial Times article, that this began to change 10-15 years ago when the debt used to fund investments rose more rapidly than the economic benefits of the investments, as I have also long argued. This left China with one of the fastest-growing debt burdens in history.
“Beijing has known the solution to this problem for years. In order to control soaring debt and the non-productive investment it funds, it had to rebalance the distribution of income by enough that growth would be driven mainly by rising consumption, as is the case in most other economies,” said Pettis in the same article.
He added, though, that this rebalancing required overcoming the politically difficult challenge of transferring as much as 10-15 percentage points of GDP from local governments to Chinese households.
The professor, in a further FT piece from April this year, argued that the Q1 2021 official Chinese data indicated that the economy had become even more unbalanced since the beginning of the pandemic.
Year-on-year exports in Q1 had grown by 13.4%, more than one and a half times the growth rate of the economy overall, while import growth at 7.5% grew more slowly than nominal GDP – and much more slowly than exports. The weaker growth in imports reflected a two-percentage point decline in consumption as a share of the overall economy.
This is consistent with ICIS Supply & Demand data and our market intelligence which shows the “China in, China out story” of H2 2020 and the first half of last year: Booming petrochemicals imports that were re-exported as finished goods as China met strong demand for durable goods in the West. It was booming exports that drove China’s big economic recovery.
Once lockdowns end, the old approach to stimulus may have limited benefits. Investment or supply-led economic stimulus has so far been Beijing’s main response to the lockdown-driven 2022 economic crisis.
“In contrast to their counterparts in most developed economies, including the US, policy makers in China since the start of the pandemic have avoided handing out cash or beefing up unemployment benefits to households,“ ,” wrote the Wall Street Journal in an article this week.
“Instead, Beijing has said it would channel cheaper loans to businesses and offer as much as Yuan2yuan (CNY)2.5tr, equivalent to $368bn, in tax refunds to companies and business owners this year,” the newspaper added.
Other supply-side measures include a reduction in mortgage rates and more spending on infrastructure.
Shen Jianguang, chief economist at JD.com, also questioned the effectiveness of existing policy responses and recommended distribution of consumption vouchers to boost demand.
“Few companies will benefit from tax cuts if the growth of their income and profits suffer sharply,” he was quoted in the WSJ as saying during a forum at Tsinghua University.
The good news is that such a policy shift would be in line with the Common Prosperity economic reforms that were launched last August, which include income and wealth redistribution to reduce China’s big regional inequalities.
The extent of the inequalities is evident from the ICIS petrochemicals data when combined with numbers from the IMF and China’s National Bureau of Statistics.
Take the chart below as an example, which shows ethylene equivalent demand in 2020 by mainland provinces and semi-autonomous regions. Ethylene equivalent demand is demand for all the derivatives made from ethylene with 2020 as the latest year for which all the necessary data was available.
The calculations were made by converting regional per capita incomes in US dollars into per capita ethylene equivalent consumption by kilogramme. The kilogrammes were then converted into tonnes and then millions of tonnes of demand by province, using the population data.
Petrochemical consumption levels in general are a pretty good proxy for levels of wealth, as the richer you are the more modern-day consumer goods, made from petrochemicals, that you can afford.
Just 39% of the population in China’s ten 10 richest mainland provinces and semi-autonomous regions accounted for 54% of ethylene equivalent consumption in 2020.
Now let us show the extent of inequality using demand for the six major ethylene derivatives in 2020.
Those of us who usually see the glass as half full will see the big opportunities from income redistribution – spreading wealth more evenly across China’s regions. This would deliver a great deal for more ethylene equivalent demand.
But what about the challenges of remaking China’s economic growth model? Transferring the 10-15 percentage points of GDP to households would be politically difficult because the old investment-led growth model benefits a lot of people, says Pettis.
The trouble is, though, that because of diminishing returns, the reduction in mortgage rates – along with a raft of other measures introduced by local authorities to boost real estate – could have very limited economic benefits.
Building more condos that that too few people want to buy because of China’s rapidly ageing population would also run counter to another Common Prosperity objective of reducing bad debts.
Assuming lockdowns do end soon (this is a big assumption, as I shall discuss shortly), the strength of any China recovery in 2022 could therefore hinge on the extent of demand-led or consumer-focused economic stimulus.
And remember: China doesn’t have the option of exporting its way to recovery because government pandemic-related stimulus is coming to an end in the West, and because of the West’s cost-of-living crisis.
The risk of major lockdowns continuing for the rest of this year
Some economists are taking cheer from the announcement that in Shanghai, which generates around 3.8% of China’s GDP, will ease its severe lockdowns will be eased from 1 June. Provided there is no resurgence in coronavirus cases, the plan is to fully re-open the city by mid-June.
But can China afford a major relaxation of the lockdowns, which, according to a Nomura estimate in early May, were affecting a total of 328m people and 31% of the country’s GDP?
On Wednesday 11 May, a peer-reviewed study by Shanghai’s Fudan University was published in the Nature journal. The study said that a decision by Chinese authorities to lift zero-COVID measures could see more than 112m symptomatic cases of coronavirus, 5m hospitalisations, and 1.55m deaths.
“We find that the level of immunity induced by the March 2022 vaccination campaign would be insufficient to prevent an Omicron wave that would result in exceeding critical care capacity with a projected intensive care unit peak demand of 15.6 times the existing capacity,” the authors wrote.
The study, however, did say that with access to vaccines and antivirals and “maintaining implementation of non-pharmaceutical interventions”, authorities could prevent the health system from being overwhelmed. It suggested these factors could be more of a focus in future policies.
But implementing changes in policies would likely take considerable time, as it might involve importing foreign vaccines that are said to be more effective than Chinese versions and raising low vaccination rates among the elderly. China’s vaccination programme has slowed down because of the lockdowns.
Another article from the FT, this time from mid-April, reported that only 57% of people over 60 had been fully vaccinated with three jabs.
A University of Hong Kong study, published in March, found that the over- 60s who had received two doses of Sinovac’s vaccine CoronaVac [a local vaccine] were three times more likely to die from Covid compared with those who received two doses of the BioNTech/Pfizer vaccine, said the FT article.
Major lockdowns might thus remain in place for the rest of this year.
Politics is another reason to suspect this might be the case. In early May, the UK’s Guardian newspaper wrote: “Xi Jinping [China’s president] has confirmed there is no intention to turn away from China’s zero-COVID commitment, in a major speech to the country’s senior officials that also warned against any criticism or doubting of the policy.
“Addressing the seven-member politburo standing committee, China’s highest decision-making body, specifically about the Shanghai outbreak, the president said China’s response was ‘scientific and effective’”. He told officials to ‘“unswervingly adhere to the general policy of dynamic zero-COVID’. “”
President Xi’s comments appear to underline the view that the zero-COVID policies won’t be relaxed until after an important political meeting in November, when the president is expected to be given a third term in office.
“One forecast number has a limited value”
Many years ago, I was told by a good contact that one forecast number for demand or supply was of limited value because of our inability to foresee events. Today’s market chaos makes a scenario-based approach even more essential for running petrochemicals businesses.
Hence, see the slide below which provides three scenarios for China’s ethylene equivalent demand growth in 2022 versus last year’s actual consumption.
Scenario 1, the ICIS Base Case, sees demand growth at 9% in 2022 over last year. I see this as possible if the major lockdowns end no later than Q3 and if there is a major shift in stimulus towards the demand or consumption side of the economy. This is very feasible, despite some of the commentary above, because of China’s proven track record of quickly reversing brief periods of declining growth.
Scenario 2, where I randomly halved growth to 4.5%, again involves the end of major lockdowns by Q3, but assumes stimulus remains mainly focused on the supply side of the economy. Demand would still bounce back, however, because of the pent-up spending of the millions of people in lockdown.
Scenario 3 would make the focus of government stimulus pretty much academic in 2022, as it assumes that large-scale lockdowns continue for the rest of this year.
The scenario involves a 3% decline in growth and is based on my recent worst-case outcomes for polyethylene (PE) demand. Reductions in demand for the other big ethylene derivatives are in line with my 12 May post, when I provided scenarios for 2022 China growth in nine major polymers.
Please note that, as always, my scenarios are for demonstration purposes only. Our analytics and consulting teams, including our excellent teams in China, can provide you with the thorough, properly calculated scenario work that you need.
To be consistent with the 12 May post, see below a chart showing the impact of these three different scenarios on global ethylene equivalent demand.
The chart underlines the crucial role that China plays in driving global demand, as under Scenario 2 global growth falls to 3% from the ICIS Base Case of 4%. Scenario 3 would result in global growth at just 1%. China’s share of global demand in 2022 would be 21%, based on our Base Case numbers.
The above chart also assumes no knock-on effect of a weaker-than-expected China on the rest of the world, as our base case numbers in Scenarios 2 and 3 were unchanged. This seems unlikely.
Conclusion: Never, ever underestimate China
I wouldn’t be surprised at all if most of the commentary in this blog proves to be wrong as we should never, ever underestimate China. A gradual relaxation of the lockdowns, combined with the right kind of stimulus, may result in a sudden take-off in consumption during the rest of this year.
And the other positive side of this story that, even if the lockdowns don’t largely come to an end in 2022, when they eventually do finish, a rapid rebound in Chinese demand is inevitable. The surge in demand could be on a scale rivalling the boom of 2009, if there is a major focus on demand-slide stimulus.
BUT STILL, China, like the rest the world, faces extraordinarily complex and difficult challenges. This makes stress-testing our businesses against worst-case outcomes so, so important.