Since early 2014, China’s economic history has been one of start-stop reforms.
President Xi Jinping’s (pictured) “Princeling” political faction began to effectively implement the bold reform vision outlined in late 2013 at the pivotal 3rd Plenum Meeting of China’s top politicians.
The Princelings are those who can trace their heritage back to the founding fathers of China’s Communist Party. They see it as more important to take the long view to tackle economic imbalances. Part of this was the slowdown in local credit growth that took place from January 2014 onwards. Any investment bubble needs more and more air pumped into it keep the bubble stable, and so when China began to pump less air into the bubble, the economy started to slow. Most people did not notice until September of that year, after which global oil, iron ore and other commodities markets collapsed.
Then the “Populists” gained more influence. This is the political faction, led by Prime Minister Li Keqiang, which prefers short-term steps to shore-up growth rather than long-term reforms.
Their influence was first seen through the stock market bubble that popped in the summer 2015, leaving investors nursing heavy losses. The credit bubble was then re-inflated in 2016 as the Populists extended their control. Too much of the lending in 2016 was used to re-inflate the real estate sector and prop-up already oversupplied manufacturing industries. Take steel as an example. Capacity on a net basis actually increased last year, despite government claims of major shutdowns.
Xi poised to cement control
Xi now appears to be back control and looks set to further cement his control at this autumn’s 19th National Party Congress meeting. That meeting might even see Li step down as prime minister, with Xi likely able to get some of his key supporters appointed to the Politburo – China’s top governing council.
Evidence of increased Princeling influence over the economy was seen in important shifts in the details of China’s lending data for January and February 2017:
■ In January, new local currency bank loans were yuan (CNY) 2.13tr ($310bn). This was far above CNY994bn in December 2016, but there is always a big seasonal surge in lending every January. Crucially, this January’s figure was below the CNY2.54trn during the same month last year. And outstanding bank loans grew at 12.6%, the slowest pace since 2006.
■ While overall February lending was more than analysts had forecast, lending by the highly speculative and risky shadow banking sector and mortgage lending were both down. For example, total household loans, which mainly involve new mortgages, fell to 26% of total lending last month, from 50% in February 2016.
China has also set its 2017 GDP growth target at around 6.5% – less than last year’s target range of 6.5-7.0%. If achieved, 6.5% growth would be less than the actual 6.7% growth claimed by China for 2016.
WHAT IS GOING TO HAPPEN NEXT?
Xi recognises that China does not have any more time to waste following last year’s re-inflation of the credit bubble, which undid much of the good work done during 2014, when reforms were powering ahead.
A new report from the Switzerland-based Bank for International Settlements (BIS), for example, concludes that China’s debt-to-GDP gap is at 26%, which is the highest in the world. The BIS believes that anything above 10% indicates elevated financial sector risks.
The government will continue its efforts to rein in the wrong kind of lending. Shadow lending will thus steadily fall throughout this year, as will lending to the real-estate sector and oversupplied manufacturing industries.
Meanwhile, lending will be increased to innovative manufacturing and service companies. These are the companies that China hopes will produce the higher-value goods and services it needs to escape its middle-income trap.
China will also spend as much as it can afford on its international economic and geopolitical integration project – One Belt, One Road – which it regards as crucial to the success of its entire economic reforms.
The net result will likely be these two things:
■ As the government has stated, slightly lower GDP growth in 2017. This could result in lower demand growth for chemicals and polymers. There is a risk of a more pronounced downturn if trade tensions build between China and the Trump White House.
■ More downward pressure on oil prices. Crude markets are waking up to the realities of supply and demand for reasons other than China. Add a slowing China to the mix and this would mean further deflationary impetus.
IMPLICATIONS FOR POLYPROPYLENE
Any slowdown in demand growth will be slight in China over the rest of 2017. We are not talking about anything approaching a collapse in growth, and of course, lower percentage increases in chemicals and polymers consumption matter much less today than decade ago. The reason is that volume-wise, demand is far greater.
A rise in supply may have a more significant impact on the improved economics of China’s coal-based chemicals and polymers plants.
Last year, China’s coal-based chemicals saw their capacity utilisation constrained by high coal prices. This was the result of an aggressive pace of coal-mine closures, and strong demand for coal from the steel sector.
The government has pledged to close fewer coal mines in 2017, and has introduced a new pricing mechanism designed to make coal cheaper.
Let’s therefore look at two different scenarios for one polymer – polypropylene (PP).
The ICIS Supply and Demand database assumes that China’s PP consumption will grow by 6% this year over 2016 to around 25m tonnes.
This assumption is based on 2017 GDP (gross domestic product) growth at 6.4%, with a multiple of PP demand growth over GDP of 0.95.
Meanwhile, local production will be at 21m tonnes, based on an operating rate of 88% from local capacity of around 24m tonnes/year in lower coal prices. This would leave room for imports at 3.7m tonnes.
In our alternative outlook, we take year’s GDP growth down to 6% on tighter credit conditions, maintain the same multiple over GDP and raise operating rates to 93%. Consumption only falls very slightly, but imports tumble to just 2.7m tonnes.
It is too early to make a definite call, but this could explain the 15% rise in Chinese PP production in January-February 2017 to 3.1m tonnes over the same period last year, according to an ICIS China assessment.
But demand, as well as supply, both remain incredibly hard to read. There is for example still a scenario where Xi backs away from economic reforms in 2017, or there is so much credit still pouring through the financial system from the 2016 rise in lending that reforms make no dent in GDP growth.
The balance of probabilities, however, suggests that Xi will accelerate reforms, and that he and fellow reformers have the ability to significantly reduce credit availability – especially from Q2 onwards of this year.
Image credit: Xinhua/REX/Shutterstock