By John Richardson
IS this the moment when Xi Jinping decides to take most of the pain of economic reforms?
A recent article in Caixin, the Chinese business and finance magazine, suggests that the moment could have arrived:
This week, the Ministry of Finance and the China Banking Regulatory Commission issued a new policy requiring “zombie enterprises” — heavily indebted companies that have no meaningful operations and are kept afloat through local government protection — to go bankrupt quickly and have their assets liquidated. Banks were told to write off loans to such companies, according to a source close to the government agencies that issued the policy.
What might be the scale of these bankruptcies if banks, prompted by local governments, are no longer as willing to rollover loans? A quarter of Chinese firms surveyed by Reuters in early October were making profits insufficient to even pay-back the interest on their loans.
Assuming that this is indeed the moment, your next question must therefore be this: Can China manage to deflate its latest real-estate bubble without suffering a financial sector crisis?
Evidence suggests that this is going to be a tall order, as I discussed on Wednesday.
It thus makes sense to plan for all of these Scenarios in 2017 and beyond. Not just 1 and maybe 2, but as I said all 3 Scenarios – and in a great deal of detail:
- The government kicks the can down the road, the real estate bubble continues and the economy continues to boom. Official GDP growth – which this year once again might understate the real expansion of the economy – will remain in the region of 6.7%
- The bubble is very gradually and very skilfully deflated, leading to only a slight decline in economic growth
- GDP growth sharply contracts, and perhaps even collapses, because of a financial sector crisis.
The Impact on China’s Polypropylene Demand
With this macro-economic framework in place you then need to obviously think through what it means for the chemicals and polymers value chains in which you operate. This will be the subject of a series of blog posts, starting with polypropylene (PP) today.
Let’s first of all focus on China’s PP market. Later on, I will consider the implications for the global PP business.
The ICIS Supply & Demand database estimates that China’s PP consumption will increase by 6.6% in 2016 over last year to 23m tonnes. And as you can see from our “base case” chart below, we expect 2017 growth to also be in the region of 6% before it gradually falls towards 5% by 2020.
So far in 2016, the mood on the ground suggests that actual annual growth might be closer to 5% rather than our forecast of 6.6%. But it is too early to come up with a definitive view.
Nevertheless, bearing in mind this market intelligence – and assuming something in between macroeconomic Scenarios 2 and 3 — I have revised-down PP growth by two percentage points for each of the years between 2017 and 2020. The end-result is this:
You will obviously notice both in our base case and in this second assumption, I have assumed the same levels of domestic PP production.
China may well continue to maximise production even if PP growth is lower because a.) It has cheap feedstocks, b.) Many of its plants are new, and so are world-scale and c.) This will be a way of creating strong regional growth as other parts of the economy slow down.
This would of course have major negative implications for how much PP China would need to import. For instance, in our base case we assume 4.8m tonnes of imports in 2017, but this falls to 3.9m tonnes in my downside set of forecasts.
Global implications for PP
The chart below, from this chapter of the IMF’s October 2016 global economic update, is very useful as it shows the growing role of China in global commodities consumption:
The IMF’s October report adds that since the mid-1990s, China’s share of global demand for base metals—iron ore, aluminium, copper, and nickel—has risen from about 3% to around 40%, while its share of demand for oil has increased from about 1% to 11%.
September 2014 all over again? That has to be a real possibility because, if you recall, the last big collapse in oil and other commodity prices was China-driven.
The crude market remains fundamentally oversupplied, in my opinion, and this week the correction might well have begun. China could again easily be the catalyst to drive prices to $30/bbl or lower.
Falling oil prices would obviously lead to a destocking process up and down every chemicals and polymers value chain. End-users would stop buying PP resin, and every other chemicals and polymer, in anticipation that tomorrow’s prices would be cheaper than today’s,
A slower Chinese economy would also have huge implications for global economic growth. As the IMF points out, 50% of the world’s GDP growth in purchasing power parity terms over the last decade has been derived from emerging markets in general, with China the biggest source of this economic expansion across all the emerging markets.
This is the result of not just the rapid growth of the Chinese economy, but the knock-on effect that this has had all the other emerging economies that export commodities to China.
And the IMF adds that this increased dependency applies to developed as well as developing economies:
Given the size and openness of the Chinese economy—the sharp increase in its share of global imports over the past decade has made it a main source of export demand for over 100 economies that account for about 80% of world GDP—the potential for large spillover effects has increased.
This Wall Street Journal blog post provides a useful table of exposure country-by-country, based on the IMF data from the same October update.
And as for PP, consider this – again from our Supply & Demand database: In 2000, China’s consumption totalled just 4m tonnes – 17% of total global demand. But in 2015 this had risen to 22m tonnes, representing no less than 34% of the global total.
The same applies to every other chemicals and polymer chains as result of China’s incredibly successful manufacturing and export-led growth.
It is thus no exaggeration to suggest that a new global economic recession could on this occasion be led by China. And there is a possibility that we could end up with a global crisis as every bit as bad as 2008.
All of the above thoughts merely scratch the surface, but I hope they have helped you get your planning process going. For more detailed scenario work you need to come to us.