China’s economy: A case of wishful thinking?


Could the chemicals industry be in danger of wanting to believe something so much that ignores overwhelming evidence to the contrary?

The widespread perception is that China’s economy has reached a turning point.

“The worst of the crisis is over and the world is entering the time when things will gradually get better,” wrote former US presidential adviser John Rutledge in an article on the Chinese news service, Xinhua.

According to The Economist, it wasn’t the collapse in exports that triggered slower growth in China.

It traces the origins of the downturn to tightening of credit in 2007 that led to a collapse in property prices in China’s first-tier cities and a decline in construction.

“If the collapse in domestic demand led China’s economy down, it can also help lead it up again. Not only is China’s fiscal stimulus one of the biggest in the world this year, but the government’s ability to ‘ask’ state-owned banks to spend and state banks to lend more means that the government’s measures are being implemented more rapidly than elsewhere,” writes the magazine.

The huge spending on infrastructure will hugely benefit rural communities as two-fifths of villages lack a paved road to the nearest market, it adds.

A large increase bank lending also appears to be behind a 36% rise in housing sales by value in the year to March after sharp falls in 2008.

If construction picks up this should help reduce unemployment as half the job losses among migrant workers have been in the building industry, the magazine continues.

But The Economist concedes that a misallocation of capital is a concern.

However, the article continues: “China is one of the few countries in the world where bank credit has fallen relative to GDP over the past five years. Banks have an average loan-to-deposit ratio of only 67%, low by international standards, and less than 5% of banks’ loans are non-performing, down from 40% in 1998.”

So in other words because the Chinese banks are awash with cash a major Western-style financial crisis seems unlikely, no matter how much money is wasted.

But if money is being misallocated, the boost to growth might be less than some people are forecasting.

There are strong rumours that easy bank loans have fuelled speculation.

“When we are selling to a trader in China they have no interest in our letters of credit because they can borrow so cheaply and so easily from their local banks. They are even prepared to pay 20% up front by telegraphic transfer,” said a Singapore-based polyolefins trader.

“I used to sell 80% to end-users and 20% to other traders in China, but now those percentages have been reversed.

“I think a lot of traders in China have taken risky long positions because lending terms were so easy.”

Money has even been borrowed and then made or lost on domestic stock markets, some sources claim.

The same might apply to the Dalian Commodity Exchange, which has seen a huge increase in trading in linear-low density polyethylene (LLDPE) over the last few weeks.

Large of inventories of steel, aluminium and concrete are being built as a result of speculation and perhaps an anticipation that demand will get better in H2. The same might apply to chemicals and polymers.

But Michael Pettis, a professor at Peking University’s Guanghau School of Management, makes some worrying observations about the economy in his blog.

It is worth reading the lengthy posts for 20 April and 13 April.

In summary, he talks about:

*Private companies – the main engine of economic growth – struggling to get financing as the state-owned enterprises receive a flood of loans

*A poor return on money spent versus jobs creation – for example, CNY1trillion which is being spent in Henan province to create 650,000 jobs. He has calculated that if this same sum had been spent on giving workers salaries of CNY3,000 a month (more than twice the average salary of migrant workers) this would have been enough to pay the wages of 650,000 people for 43 years

*A boost in industrial production, “leaving the unresolved question of who is going to absorb the excess capacity if the US is no longer willing to play the role”

*Signs that China is trying to export its way out of oversupply. The trade surplus was $62.6bbn in Q1 this year, up from $41.7bn for the same period in 2008. “Although lower than the astonishing heights of January and late last year, the trade surplus is still much higher than this time last year. That means China’s export of overcapacity is increasing,” he writes

*A much larger vulnerability of GDP (gross domestic product) to exports than some economists have calculated. He quotes a Wall Street Journal article, quoting a working paper prepared for the International Monetary Fund. The paper estimates that for every 10% fall in exports, GDP will decline by 2.5%. Exports fell by 20% in the first quarter

*Government subsidies and tax distorting demand – for example, state-owned enterprises bringing forward vehicle purchases which was of the major reasons why auto sales rose by 10% in March. JD Power, the car consultancy, is forecasting flat Chinese passenger car sales in 2009

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