The Worst Things Get The Better They Are

By John Richardson

THE more that China’s economy weakens, the greater the hope of a recovery in the second half of this year.

This type of thinking was in evidence last week. The release of a raft of disappointing economic data for April boosted the confidence of some people in the petrochemicals industry that China’s government would have to do something pretty drastic to solve the problem.

The release of the weak data contributed to further declines across a broad range of petrochemicals.

Polyolefins took the biggest hit. Asian polyethylene (PE) pricing was down by $90-130/tonne with polypropylene (PP) $70-130/tonne lower for the week ending 11 May, according to ICIS.

But China’s top leaders seem to have other things on their minds along with the economy.

China, as it prepares for this year’s once-in-a-decade leadership transition, is in the midst of its biggest political crisis since Tiananmen Square in 1989, say numerous commentators.

This is the result of the ouster of Bo Xilai, the former Chongqing Communist Party head.

The country’s nine-member politburo was so divided over Bo that it could not even agree on an interest-rate cut, said the UK’s Financial Times.

A 50 basis-point cut in bank reserve requirements was announced last Saturday, following the release of the bad April data.

But the FT made the point that adjustments to the reserve requirement did not require politburo approval.

“It is not only politics that is holding back a cut in interest rates. The threat of inflation is another factor,” said a senior executive with a global polyolefins producer.

Overall inflation fell in April to 3.4% from 3.6% in March, well within the government’s annualised target of 4%. However, food-price inflation in April was still high – at 7%.

Lower borrowing costs might add to food-price inflation, thus hurting low-paid workers who spend a big proportion of their incomes on food. This would contradict one of the main objectives of the government’s 12th Five-Year-Plan (2011-2015), which is to reduce income inequality.

Implementation of the plan is also acting as a further drag on growth.

Another problem is that despite three reductions in the reserve requirement since late last year, which has released many billions more dollars into the financial system, small and medium-sized enterprises (SMEs) are reported to remain short of credit.

“The SMEs are still finding it difficult to get hold of financing and so the government needs to take further measures,” added the polyolefins industry executive. SMEs buy the majority of chemicals and polymers in China.

But perhaps all this talk about the need for cheaper, more easily-available borrowing entirely misses the point.

The real issue could well be that companies are very reluctant to take-on debt because of exceptional levels of uncertainty over domestic politics and the global economy.

“Our customers in China have become cautious and will, I think, remain so until the end of this year,” said a source with another global polyolefins producer.”Even if the global economic

environment improves, uncertainty over the outcome of the leadership transition is going to limit their appetite for credit risk.”

An improvement in the global economy, given recent events in Greece, appears highly unlikely right now.

China, despite all the talk about rebalancing, remains heavily dependent on exports – and Europe is its biggest trading partner.

Some of the bad economic data for April reflected the current plight of manufacturers in this difficult environment.

Overall exports grew by just 4.9% in April compared with the same month in 2011.This was half as much as economists had expected and followed a disappointing Canton Trade Fair.

Growth in industrial production was also only 9.3% in April year-on-year, the weakest reading in three years and well below the 11.9% increase in March.

“A Middle East solvents producer says his pace of orders in 2012 has been well below that of the previous two years. He sells mainly to customers in China, who then re-export finished products such as leather upholstery,” said an industry observer.

And he added that Middle East producers in general have turned bearish over China.

“The Saudis say that Asian demand has become much weaker since the end of April,” he said.

“The drop in energy prices, and hence the resulting expectation of lower derivative prices, is also keeping the customers at bay and they are only buying what they need.

“This is not atypical of Chinese buying behaviour. They don’t buy when prices are falling, but instead start buying when prices turn upward.”

But, sadly, all the evidence points to this being much more than the standard “China has stopped buying” story.

Something much more fundamental seems to be going on.

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