International | Jun 01 2010
By Greg Peel
Beijing has been providing stimulus to China's domestic economy since late 2008 in an attempt to reduce the Chinese economy's reliance on export sales alone but also to help stabilise the global economy through renewed, and significant, commodity demand. It made sense for China to buy up record amounts of commodities through 2009 anyway given prices had fallen substantially, and it made sense for China to try to help its export customers back to their feet.
The plan worked, rather too well. China's GDP growth rate quickly returned from levels below 7% to around 12% and soon Beijing was tightening its previously easy lending policy. The Premier declared in a early 2010 a target growth rate of only 8% which spooked Australian markets given it implied a decline in demand for commodities from now elevated levels – those which had meant Australia had completed avoided recession.
While Beijing's underlying desire was to simply slow an economy which was threatening to overheat yet again, a bubbling speculative property market had become of specific concern. The Premier was not shy in the declaration of his desire to burst the bubble and smash the speculators, which made the Australian market even more nervous given the size of the Chinese property sector and its consumption of materials such as steel and copper.
Then along came the European crisis, and the world became very concerned that its post-GFC saviour would keep on slowing its economy at a time when Europe's economy would head back into recession. It would be a double-whammy effect. But it would make sense that China would see no need to keep up aggressive tightening measures now that its biggest export customer – Europe – was under threat. Surely European contraction would provide Beijing with the economic slowing it needed?
Another concern which is now brewing is that a loss of European demand and a drop in Chinese property would mean China may simply turn to accessing the stockpiles of commodities it spent about a year buying to service its slower growth, rather than continue to aggressively buy more. It seems there may be many ways the bottom could suddenly fall out of rapidly recovered commodity demand, and that's not comforting for Australia.
The official Chinese PMI performance of manufacturing index released this morning showed a drop in May to 53.9 from 55.7 in April. Economists were expecting a reading of 54.5. The independently calculated HSBC equivalent index dropped to 52.7 from 55.2. The drops indicate tightening measures and property price falls have indeed had their effect, but it also marks the fifteenth straight month of manufacturing sector expansion. Only numbers below 50 indicate contraction, so one may simply state Beijing's policies are working and there is little to be concerned about. But the market is nervous.
The market has been nervous enough for various foreign analysts to make the trip to China last week to get a better idea of what's really happening at the coal face.
Citi's Asia Pacific economists met last week with officials from China's central bank and banking regulator as well as international organisations and research houses.
Citi believes fear in the market surrounding Europe has been overdone, but found this was a unanimous near-term concern at its meetings. The economists thus believe the likelihood of further tightening measures is reduced, although they do still see a renminbi revaluation some time later in the year, with inflation the swing factor.
Citi sees property prices and investment growth slowing, but suggests liquidity will still remain “rich” and the government's social housing program will help to buffer investment. The economists are sticking with their Chinese GDP growth forecast of 10.5% in 2010.
The UBS global equity research analysts decided they would organise industry meetings and site visits in Beijing, Shanghai and Taiwan last week. What they found was a generally positive market outlook and a “quiet confidence” in the government's policies to stabilise growth following the rapid bounce of 2009. The greatest impact from policy measures is expected in the second half of 2010.
What was more interesting is that the locals don't see any real “property bubble” at all, according to UBS' conversations. Only the high end, being less than 10% of the total market, is experiencing large price jumps while elsewhere moves are more modest by historical standards.
The locals were less concerned about a falling property market reducing demand for steel than they were about “irrational” miners bumping up prices for iron ore and coal, UBS reports. (Which would include the same miners currently calling the Australian government irrational and so the accusation wheel turns.) Higher raw material prices were impacting on Chinese steelmakers' margins, and local analysts suggest attempts to buffer margins through steel price rises will soon undermine steel demand growth.
So it's not about the Chinese property market apparently, or about Europe, it's about those greedy iron ore miners across the Pacific. But if you don't like the price, why buy the iron ore?
Macquarie's economic research team notes that while the potential for a weaker Chinese property market was scary news a few months ago, an actual fall in property prices is now welcomed because this means there's less need for Beijing to further tighten its policy. Indeed, Macquarie is flagging the idea of Beijing possibly easing its policy measures once more, and that would be very good news for a nervous market.
The stumbling block would be inflation. Chinese inflation had begun to tick up again in recent months and tightening measures were as much about heading off this threat as they were a means to kill of property speculators. Beijing is unlikely to return to easier policy if inflation concerns remain. But Macquarie notes food prices in China have fallen 6% in May, suggesting May CPI inflation should remain below the government's 3% target.
Citi may see China's social housing policy as a buffer against wholesale property price falls but Macquarie doesn't see it as “a magic way out”, and suggests Beijing's building targets are “too high to be believable”. In the 2007-08 slump, Chinese real estate fixed asset investment dropped from 30% growth to 5% and the Macquarie economists can't see why a similar drop could not be expected.
But this puts us in the unusual position of actually cheering on a property price fall in China such that policy easing measures can be expedited. Given Macquarie's weaker view on property than the other brokers cited above, the economists are expecting policy easing by year-end, and expectation of such building into markets in the northern summer months.
The net result would appear to be that China will certainly not exacerbate global economic problems in the wake of the European crisis, but rather use domestic monetary policy to sterilise them. Hero one minute and villain the next, Beijing might be a hero once more.
That doesn't necessarily mean, however, that China will simply go on buying up commodities with the same abandon as it did in 2009. The concern now is that a weaker property market and weaker export demand from Europe will see China turning to its commodity stockpiles as a source of materials, rather than buying more.
The Macqaurie commodities research team note China's April production and trade data confirm a trend of slowing commodity imports. This reflects ongoing destocking which began in the third quarter of 2009 as well as a ramp up of local commodity production in response to higher prices.
China was a net importer of aluminium, lead and steel over the first four months of 2009 but in the first four months of 2010 it has become a rising net exporter, notes Macquarie. Flat steel exports out of China are back at peak levels and imports of refined zinc, nickel and tin have “collapsed” compared to a year earlier. The reason global commodity prices have not reflected such a turnaround is a strong recovery in non-Chinese demand so far this year.
Nevertheless, Macquarie is not overly concerned. The analysts suggest only a slowing of the rate of base metal and steel demand growth, in part reflecting some destocking activity, rather than an actual contraction in demand. “Once this destocking is complete,” says Macquarie, “apparent demand will start to rise again”.
The Wall Street Journal has also spoken to analysts who have made the trip to China lately, and reports confirm domestic demand is still strong. Suggestions are that the tapping of reserves of commodities is only part of the reason why import data are weak. The other reason is that manufacturers are now holding out in expectation of lower prices given the China property/ European export story.
Analysts suggested that longer-term, the WSJ reports, the Chinese government and industrial companies are likely to return to the market when reserves are running down or prices become low enough.
After all, it would be hard to drive 12% GDP growth to date with a focus on domestic infrastructure if you weren't rapidly using up raw materials, one presumes.
