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China’s real estate rescue and zero-COVID tinkering will make little difference

China, Economics, Middle East, Oil & Gas, Olefins, Polyolefins, Singapore, South Korea, Technology, Thailand
By John Richardson on 16-Nov-2022

By John Richardson

CHINA HAS launched perhaps its biggest set of economic easing measures since the Common Prosperity economic reforms began in August 2021, through a 16-point plan designed to shore-up the property sector.

One of results of the plan has been an increase in polyethylene (PE) and polypropylene ((PP) pricing. CFR China linear-low density PE (LLDPE) prices have risen by $20-40/tonne since the announcement with CFR China PP prices $30/tonne higher.

The most important of the16 measures is allowing Chinese lenders an unspecified amount of time to cap the portion of their outstanding property loans at big banks at 40% of total loans and outstanding mortgages at 32.5%, according to this 14 November article in the Financial Times. The deadline for achieving the targets had been 31 December this year.

“Cash-strapped developers (especially private ones) construction companies, mortgage borrowers and other related stakeholders can now breathe a sigh of relief,” wrote Nomura in a report quoted by the FT.

While pressure on excessive lending remains, the measures offer relief for commercial banks. The banks now have leeway to issue new loans. But as with previous stimulus measures introduced since the start of the Common Prosperity reforms, the effects of the 16-point package are likely to be muted.

What will continue to undermine demand for real estate is the end of the government “put option,” the long-standing belief that the government would always intervene to prevent property prices from declining. This gave investors the confidence to buy multiple properties, which often involved plots of land where construction of homes had yet to start.

The “put option” came to an end with the introduction of the Common Prosperity reforms that centre on reducing income inequality and bad debts. The property bubble is the primary cause of big increases in economic inequality and bad debt since 2009, so reflation of the bubble cannot happen, in my view.

And as Reuters wrote in this 14 November article: “While the [real estate] measures will stave off an imminent wave of defaults, a rescue this is not.

“Real estate, contributing roughly a quarter of China’s $17tr of output, is a speculative monster that has cannibalised capital better used for other endeavours. This may be why President Xi Jinping is reluctant to bail it out despite the cost.”

The plan was designed merely to help stave off a liquidity crisis among developers resulting from the “three red-line” limits on lending introduced in 2020, added Reuters.

The measures will also enable developers to complete unfinished properties, reducing the risk of social unrest among the millions of investors who have paid for homes that haven’t been built. But this is not the same as pumping more air into the property bubble.

And because the government “put option” no longer supports sentiment, confidence in real estate has been undermined – perhaps for good. This is an asset class where perception is just about everything.

Despite all the talk about zero-COVID restrictions being relaxed, the bulk of the restrictions remain firmly in place. The minor relaxations of the restrictions may even be a sign that strict lockdowns and quarantine rules will remain in place well into 2023.

“These policy adjustments look more like efforts to sustain zero-COVID,” said Yanzhong Huang, a senior fellow for global health at the Council on Foreign Relations, in a 14 November Time article.

Because China’s vaccines are said to be ineffective in limiting severe symptoms, a major rollback of zero-COVID carries the risk of hospitals been overwhelmed with admissions, estimated by Nature magazine at 15.6 times capacity.

Zero-COVID is undermining economic growth. This makes it even more unlikely that the real-estate rescue initiative will lead to a flood of new property purchases.

“One in five urban youth in the country are jobless, business meetings and trade shows are being postponed or cancelled, and workplaces are regularly shuttered over concerns about the coronavirus, including the recent lockdown at a Foxconn manufacturing centre,” wrote Matthew Bossons, a Shanghai-based journalist, in this 14 November CNN article.

China’s economic challenges also include a decline in exports resulting from the global inflation crisis and a rapidly ageing population.

China spreads and LLDPE demand, net imports in 2023

The chart below shows how in January-October 2022, spreads between CFR (cost & freight) Japan naphtha costs and CFR China LLDPE prices averaged just $272/tonne, the lowest annual average since our pricing assessments began in 1993. The previous lowest spread was $300/tonne in 2002. The average 1993-2021 spread was $514/tonne.

Why chemicals and polymer price spreads over feedstock costs in general are so useful is because our industry provides the raw material building blocks for many manufacturing chains. What is happening in our industry is thus an excellent barometer for broader economies.

The chart below – which shows actual monthly naphtha and LLDPE prices from November 1992 to October 2022 – is also valuable.

It tells us that during previous rapid run-ups in crude prices, such as in 2009-2011, LLDPE producers had much more pricing power than today. They were much better able to pass on higher raw material costs as the gaps between the red and blue lines show.

I see it as very likely that China LLDPE and other spreads will remain depressed in 2023 because of the economic difficulties detailed above.

This leads me to my latest outlook for Chinese demand in 2023. The chart below indicates what I think will happen to next year’s LLDPE consumption.

Based on the January-September data (net imports plus local production), China’s LLDPE demand for the full year of 2022 looks like it will decline by 4%. This 4% decline is the starting point for three scenarios for demand in 2023:

  • Scenario One involves flat growth over 2022 and a market of around 14.7m tonnes. This would be the result of zero-COVID restrictions being substantially relaxed. This outcome also sees an improvement in the global economy because of perhaps an easing of some of the supply-chain driven inflation caused by the pandemic
  • Scenario Two would see demand falling by 3%. The zero-COVID rules would remain in place, but the global economy would improve. Demand would be 14.2m tonnes
  • Scenario Three would see the worst of all worlds: Bo zero-COVID relaxation and a weaker global economy, leading to a 6% fall in consumption to 13.8m tonnes

Completing the picture is the chart below, showing three outcomes for LLDPE net imports in 2023. These scenarios are built on net imports at some 4.8m tonnes in 2022, which is again what is suggested by the January-September data.

The scenarios for 2023 net imports follow the demand-growth outcomes in the previous chart:

  • Scenario One would see net imports of 4.4m tonnes on flat demand growth and the 83% local operating rate forecast in the ICIS Supply & Demand Database
  • Scenario Two would involve minus 3% growth and again our base case operating rate of 83%, leaving net imports at 3.9m tonnes
  • But Scenario Three assumes a higher operating rate of 85% on China seeking to maximise self-sufficiency. With demand growth falling by 6%, net imports would be just 3.2m tonnes

More dead cat bounces ahead

I love cats, so I always cringe at the old cliché, “a dead cat bounce”. But it is appropriate for today’s circumstances. We will see lots of rebounds in markets that won’t last, such as this week’s recovery in Chinese equities and polyolefins pricing on the real-estate rescue package and the tinkering with the zero-COVID rules.

Reasons for further short-lived rebounds might include more economic stimulus by Beijing. But major resets in economic policies are unlikely because of the firm commitment to Common Prosperity. And until China can revaccinate enough people with mRNA vaccines, the zero-COVID policies may have to remain in place.

China is also far from being an economic island. A lasting recovery can only happen when the rest of the world gets on top of record-high inflation and that might be at least a year away. Around 20% of Chinese GDP comprises exports.

It is therefore prudent to take a conservative view of Chinese chemicals demand in 2023. Also consider building into your scenarios further sharp declines in net imports in some value chains because of rising self-sufficiency.