Adjusting Inventories To Lower China Growth


By John Richardson

EXCESSIVE inventory building across a range of commodities in China, including  petrochemicals, continues to worry the blog.

One reason, as we discussed yesterday, might be that traders are in the midst of a liquidity squeeze as a result of the late June credit crackdown. They have therefore taken out further very-aggressive positions in an attempt to avoid bankruptcies.

Another explanation, which we talked about last week, is that the inventory building has been because optimism is back in fashion amongst traders in China due to the greater availability of credit in Q1 and growing confidence that the Chinese economy is re-accelerating.

Connected to this second theory is the argument that Martin Wolf made in this very thought-provoking article in the Financial Times last month.

He contends that China, and the world in general, has yet to wake up to the longer-term consequences of economic rebalancing.

Wolf argues, using the charts above to support his case, that China has made good progress in shifting its economy away from too heavy a reliance on domestic investment and exports towards a much greater dependence on local consumption.

But he adds that a lot more needs to be done.

The long-term outlook for GDP growth has therefore shifted from around 10% to about 6% per year (quite likely, we think, much lower), he believes.

Producers, traders and end-users in every manufacturing chain must, as a result, adjust their thinking on stock-building, he says.

“Investment in inventories must fall sharply, since its level depends on the growth of an economy not on the level of activity,” writes Wolf.

“Think about it: in a stagnant economy, inventory accumulation would normally be zero. Other things equal, an economy growing at 6% would need 60% of the investment in inventories of one growing at 10%.

“The immediate impact of this adjustment would be a sharp decline in investment in inventories, before their growth resumed at 6% a year, from the now lower level.

“Moreover, businesses might well fail to anticipate the economy’s slowdown altogether, particularly after years of far higher economic growth. They would find themselves burdened with rapidly rising inventories and would then be obliged to slash inventories, and so levels of output, even further.”

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