By John Richardson
MORGAN Stanley has once again produced a very bullish forecast for China’s polyethylene (PE) market.
The investment bank was famous for devising the SuperCycle theory in late 2010. It failed to take into account clear signs that 2011 was going to be a bad year.
Version 2.0 of its bullish view on the industry assumes that 2011 was so exceptionally bad that it is confusing us about the longer-term picture.
Here are the investment bank’s main arguments, with our counterviews in italics:
*The underlying growth of Chinese PE demand has been hugely underestimated because the distorting effects of inventory build-ups have not been taken to account, according to a report by Morgan Stanley analyst, Vincent Andrews. For example, China Petroleum and Chemical Industry Association (CPIA) data for January-November 2011 show a 2 percent fall in demand when, in fact, it actually increased by 15 percent in the same timeframe. In November, PE demand rose by a staggering 23 percent. We believe that PE demand was brought forward by the huge economic stimulus of 2009-2010 and so destocking was, indeed, inevitable. However, all the reports from the industry that we have received indicate that “underlying demand,” whatever that means, has fallen. Converters have been running at low operating rates because of lack of credit and nothing short of a collapse in export orders to the West. General anxiety over the economy, including the fall in property prices, has also weakened consumer spending, say the people we talk to.
*The compound annual PE growth rate will be 7.8 percent in 2011-2016 with the potential to surprise on the upside. This will be the result of the renewed “pro-growth” policy of the Chinese government as it relaxes lending conditions; increasing urbanisation, leading to a substantial boost to growth as relocated workers receive extra government benefits; what Morgan Stanley calls “industrial upgrades” – i.e. the percentage of the workforce with college degrees, which is set to rise from 10% today to 35% by 2020. It is widely accepted that the Chinese government has very little room to stimulate the economy, given the danger of reigniting socially divisive and economically damaging inflation; the pace of urbanisation looks set to slow down because of declining export growth. Where are the jobs going to come from to maintain historic rates of urbanisation, given that the economy remains dangerously reliant on exports? True, the rise in college graduates represents an opportunity, but also a threat to social stability if not enough new jobs are created.
*”By 2015, people born after 1980 will represent 50 percent of China’s population. We expect this group to desire greater product substitutes, much like US Babyboomers did in the 1960s, necessitating increased manufacturing to keep pace with consumer demand,” writes Andrews. This is contrary to the views of demographers who believe that China’s ageing population, the result of its disastrous one-child policy, will be a drag on economic growth; as economist Nicholas Lardy points out in his new book, China’s growth model has held-back the increase in incomes versus capital formation as an economic driver; 96 percent of China’s population lives on less than $20 a day, according to the Asian Development Bank, and so a comparison with the post Second World War boom years in the US, when average real per capita income levels adjusted for inflation were far higher than in China today, is a little dangerous; and we also cannot discount the risk that Chinese growth will be severely dented by a bad-debt crisis worse than sub-prime in the US.
We could very easily be wrong, but it is always worth planning for a range of possible outcomes.