China’s Growth In 2010: Two Theories

More buying of junk in H1 next year that nobody really needs?




By John Richardson

TWO theories about growth in China next year revolve around either an appreciation or devaluation of the Yuan.

The appreciation theory is far more widespread as it assumes no global double-dip economic recession.

It’s assumed that by mid-2010 inflationary pressures will be build to the point where fiscal tightening will be needed, through, for instance, a cut in new loans and a rise in interest rates.

Part of this tightening would also include a long-awaited appreciation of the Yuan from around 6.8 to the US dollar, where it is at the moment, to 4.8.

Until and if this happens we could continue to see hot money pouring into and around China’s economy as everyone tries to maximise Yuan revenue ahead any appreciation.

Weird and wonderful speculation

This has led to all sorts of weird and wonderful examples of speculation this year, including in chemicals markets.

My very able colleagues at CBI tell me, for example, that cargoes are sometimes being bought for the sake of the credit that is then used to punt in another commodity – for instance, equities.

There was one case of an ethylene dichloride (EDC) shipment that was sold at below raw material costs because the trader had used his credit to make a fortune from speculating elsewhere.

More such speculation will happen in H1 next year if the motive to gamble in order to make a currency gain remains high, particularly if economic policy stays broadly on the same expansionary track.

Yesterday, the State Council announced that economic policy would stay mainly unchanged for the time being because of a continued focus on boosting domestic consumption.

Some new pro-consumption measures are to be introduced, such as increasing cash-for-clunker car rebates.

Trying to let the air out gently

But two measures were also announced yesterday that might slightly deflate very bubbly auto and housing markets. As we reported yesterday, auto sales in November increased by 96% year-on-year.

The air-sucking steps are:

*The purchase tax on cars with engine sizes of 1.6 litres or less will be raised to 7.5 percent from 5 percent, though that is still lower than the 10 percent tax rate for most other cars

*Individuals must own their homes for five years to be eligible for sales tax exemption, up from the previous minimum of two years. In July, the China Banking Regulatory Commission decided to tighten mortgage conditions for second-time homeowners and big banks announced that they would start to offer discounts on mortgages only to selected qualified applicants

Government policy makers have a poor record of implementing the right housing policies at the right time, says Rosealea Yao of the Beijing-based online economics research publication, The China Economic Quarterly (CEQ).

The reason is that data on the property market can be misleading.

For example, there’s recent evidence that stocks of unsold homes are increasing in several local markets, such as Beijing, Shenzhen and Hangzhou, whereas year-on-year nationwide sales accelerated by 48% in October.

A heavy-handed approach in 2007, involving interest rate rises and a reduction in credit to developers, caused the last collapse in China’s property markets.

So the point she makes that if further measures are needed to cool the housing market and the overall economy down from mid-2010 – which the CEQ believes will be the case – the central government needs to tread very carefully.

The dilemma for China is that while a healthy construction sector is crucial for the economy, so is making sure that property prices don’t increase out of the range of average earners.


Expect even more chemicals volatility

It seems very possible, therefore, that if inflationary pressures do start to build, chemicals pricing could become even more volatile and unpredictable ahead of any new government measures.

“There have been much closer links this year between overall economic sentiment, reflected in global and local equity markets, and what’s happening in polyolefin pricing and trading patterns,” said an industry source.

So when the rumour-mill starts churning about fiscal tightening, expect to see polyolefin markets – and perhaps chemicals markets in general – responding to fluctuations in share prices.

These fluctuations might, of course, have no relevance whatsoever to the underlying fundamentals of chemicals supply and demand.


What about the other theory?

We have long-argued on this blog that oil prices are way out-of-kilter with immediate demand.

They have been this way since 2006, but right now the fragile global economic recovery has increased the risk of a sudden and sharp correction.

Some unforeseen crisis, more globally systemic than Dubai World, could result in a retreat to the US dollar and a collapse in crude back to $30-40 a barrel (where some believe it should be based on the physical market fundamentals).

This would result in the Yuan appreciating much faster than the Chinese want – because of its link to the dollar – as they try to gradually rebalance their economy away from exports and towards more domestic consumption.

A competitive devaluation of the Yuan might then take place in order to protect export trade, leading to deflationary pressures from Chinese exporters. We could then be in the middle of major global trade war.

Let’s hope for a more benign outcome!!

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