China stimulus could be a one-off

Source: ECN

2019/03/22

China’s huge January credit increase might be the start of a new round of major credit-fuelled economic stimulus, was the theory we put forward in the 8 March issue of this magazine (ICB, 8 March, p26).

This would lead to a rebound in global growth and a surge in worldwide chemicals demand as global growth is about these three things: China, China and China. No other country or region plays anywhere close as big a role in consumption and the growth in demand.

Demand growth in China for polymers that go into “big ticket” durable items was weaker than had been expected in 2018 because of tight credit conditions (see the final section below: Implications for chemicals demand).

We could therefore see a big rebound in demand for some polymers such as polypropylene (PP), which suffered from last year’s decline in auto sales, if the January rise in lending is sustained.

But I think it is possible that that the surge in January Total Social Financing (TSF) was about panic over growing financial risks rather than a long-term return to very relaxed lending conditions. TSF is a broad measure of lending and liquidity in the economy.

January’s TSF was at its highest monthly level since the government started releasing the data in January 2002. The January TSF of Rmb4.64tr ($690bn) was one-third higher than the same month last year.

If the panic scenario is correct then January’s TSF was just a one-off. Much of the extra January credit would be used to shore-up companies at risk, instead of generating new economic activity.

But it is also possible that China will be forced to open the long term credit floodgates again, similar to the scale of 2009-2017. During those years, China was responsible for 50% total global economic stimulus as it responded to the global financial crisis.

China may be forced to take such a radical step if the trade talks with the US fail and the trade war continues. As this article went to press, the prospects of a deal had dimmed slightly. Who really knows, though? A deal has been on, off, on and perhaps back off again, since January.

JANUARY TSF A ONE-OFF?

Nearly 90% of corporate bond defaults in 2018 involved private companies. Last year’s CNY151bn of total bond defaults was the highest in Chinese financial history.

A reason for these defaults was the big impact on private companies of last year’s 73% fall in shadow bank lending, as it is the shadow or private banks that are the main lenders to the private sector.

There are also seems to have been a structural shift in lending away from the private companies and towards the state-owned enterprises (SOEs).

This is to do with politics. In 2016, private companies received just 11% of new loans, down from 52% in 2012, according to economist Nicholas Lardy in his new book on China, The State Strikes Back.

This is despite the private sector accounting for 60% of GDP growth and 90% of new employment. The shift in lending is the result of what Lardy says is greater central control of the economy since President Xi Jinping came to office in 2013.

The January flood of TSF appears to be partly about trying to redress shortages of funds for private companies. So is the case with reductions in bank reserve requirements and government instructions to banks to lend more to private companies.

Earlier this month, Qinghai Provincial Investment Group unexpectedly missed domestic and overseas bond payments.

Although payments on the bonds were eventually made, the short-lived technical default shocked analysts, as Qinghai Provincial is an SOE. This was the first offshore default by an SOE in more than 20 years.

Qinghai Provincial is an aluminium and a hydropower producer and a Local Government Financing Vehicle (LGFV).

These vehicles have been used to fund China’s spending on roads, railways, subways and bridges etc.

Spending on infrastructure has ebbed and flowed over the last ten years, based on whether China felt it needed to support gross domestic product (GDP) growth or tackle bad debt problems. There was a major policy shift last July when Beijing decided to compensate for the economic slowdown by spending more on infrastructure, with the LGFVs the vehicles for this expenditure.

The January boost in TSF therefore seems to be about ensuring that other LGFVs do not default on their debts

CHINA MUDDLING THROUGH

What if the government was right to panic in January, but there is little it can do to avoid a major bad debt crisis?

A record CNY6.7tr in outstanding corporate debt is set to mature this year and 
will have to be rolled over, just as bond issuance increases to support more infrastructure spending.

Last July’s decision to boost spending on infrastructure came at a time when excessive investment in bridges, subways etc. was already a concern.

Take as an example subway spending in Suzhou, a city 100km from Shanghai. One subway stop sees just 100 passengers a day, according to an article in the Financial Times last December. Between 2014 and 2017, China accounted for 30% of global city subway rail lines but only 25% of passengers.

Before the July turnaround, Beijing had warned that some subway projects were “not based on actual needs” and had “increased the burden of local debt”, added the Financial Times.

Total Chinese debt as a percentage of GDP increased from just 162% in 2008 to around 300% in 2018. This was the result of the huge post-global financial crisis economic stimulus that led to not only major spending on infrastructure, but also a property bubble and manufacturing overcapacity.

China has so far managed to muddle through without a debt-induced economic crisis. I believe it can continue to do so in 2019 if it maintains its focus on reducing bad debts.

Of course, it wants to maintain this focus. This is why it is possible that the January TSF was a one off.

While more stimulus measures have been announced since January, such as reductions in value-added taxes, the government’s focus on controlling leverage may mean no return to the heady stimulus days of 2010. In that year, bank lending tripled compared with 2009.

“China will face a graver and more complicated environment as well as risks and challenges that are greater in number and size. China must be fully prepared for a tough struggle,” said Prime Minister Li Keqiang, during his work report to the National People’s Congress, the annual parliamentary meeting. The meeting took place earlier this month.

His comments add weight to the scenario of no new major credit boom.

But, as we said at the beginning, there is the increased risk that the trade war will note be resolved.

In summary, here are the two potential outcomes.

■ The credit floodgates are not re-opened because a trade deal has been signed. Additional economic stimulus bolsters Chinese growth and chemicals during H1. But the breathing space provided by the trade deal gives President Xi the ability to resume economic reforms. Credit becomes tight again in the second half of 2019.

■ There is no trade deal, China floods its economy with extra lending and introduces other stimulus measures. The global economy enjoys stronger growth and oil and chemicals prices move much higher. This makes China’s already very serious bad debt problem even worse, leading to an eventual economic crisis.

IMPLICATIONS FOR CHEMS DEMAND

The chart shows my ratings of key polymers – high, medium and low – based on their exposure to the ebbs and flows of economic stimulus in China.

It is important to think separately about the implications for durable and non-durable end-use chemicals applications in order to understand the basis for these assumptions.

A lot of PP, as mentioned above, goes into durable big ticket, or expensive, applications such as autos, where the slowdown in credit growth was keenly felt last year.

The same applies to acrylonitrile butadiene styrene (ABS) and high-impact polystyrene. The 2018 data for these products show demand growth less than we had forecast.

We don’t as yet have the 2018 data for polyvinyl chloride (PVC). But it is one of the polymers most exposed to credit cycles because of its heavy links to the construction sector. PVC is used to make water and sewerage pipes and window frames.

This explains the high risk ratings for PP, ABS and PVC. But general purpose PS (GPPS) and expandable PS (EPS) had terrific years in 2018. So did, most spectacularly of all, polyethylene (PE) where demand was as much as 1m tonnes more than we had expected. PE demand growth was so strong in China that it accounted for 62% of total global demand growth, up from 53% in 2017.

Last year’s PE demand will have totalled around 31m tonnes. In 2009, Chinese consumption was just 15.6m tonnes

What GPPS, EPS and PE have in common is that they are heavily used to package non-durable low-cost essential goods, including food in the case of PE.

Last year’s credit slowdown had therefore no discernible effect on demand for these polymers in 2018 – and there is no reason to believe that credit availability will have any influence in 2019.

The three polymers also benefited from the heavy restrictions on imports of scrap or recycled plastics and cardboard that China introduced from January 2018 for environmental reasons.

This meant that packaging materials that had been made from recycled plastics and cardboard had to be replaced with virgin GPPS. EPS and PE.

GPPS, EPS and PE were also boosted by the continued growth in internet sales. China has become one of the world’s most wired countries. One factor driving internet sales is the anxiety over food safety. Growth in sales of foreign food over the internet has been strong because of the severe pollution of Chinese soil and water.

Low-density PE (LDPE) and linear-low density PE (LLDPE) films are heavily used for packaging cheap consumer goods. High-density PE is also used to detergent and shampoo bottles etc. which are also, of course low cost. You don’t stop washing your hair when the economy slows down. But HDPE also has big ticket durable applications in petrol tanks for autos and in, more importantly, pipe grade HDPE for water and natural gas pipes. HDPE pipe grade demand is thus vulnerable to the ebbs and flows of Chinese infrastructure spending.

This explains why PE is categorised as being at medium risk to falling and rise Chinese economic stimulus whereas EPS is low risk.

PS is categorised as medium risk. While, as we said, GPPS benefited from the recycling restrictions and rising internet sales, high-impact PS (HIPS) – the other grade of PS - suffered from the credit slowdown. HIPS goes into more expensive end-use applications such as electronics.

You can also see in the same chart on p27 estimated Chinese consumption for these polymers as percentages of total global demand.

Extraordinary. These percentages once again tell us how no other global market compares to China as a driver of demand. This why the extent of China’s credit growth in 2019 has big global implications, as is the case every year.