China faces uncertain future as cracks appear in economy
China’s economy is facing strong tests and any sign of weakness will hit bullish projections for its oil-demand growth
The world’s second-largest oil consumer is facing strong headwinds. After years of blistering economic growth, concern is mounting over inflation, an ailing property market, growing local government debts and the possibility that big state-owned banks could be at risk. Economic weakness in Europe, Japan and the US is also converging to dampen the very force that has fuelled China’s insatiable consumption of oil and other commodities: exports.
Cracks are starting to appear. Although the economy performed better in late 2011 than predicted, trade numbers show that sales of Chinese goods abroad did not grow as hoped. A severe slump in the surplus, from $305 billion in 2010 to $29 billion in 2011, shaved 0.5% off overall economic growth.
And last month, China swung into a huge trade deficit of $31.5 billion – far more than the median forecast of $8.5 billion – underscoring concerns about slowing global consumer demand and cooling domestic growth. The fall in exports, combined with spectacularly strong imports as China continued to buy raw materials such as crude and iron ore, left the trade deficit standing at its highest point since the 1990s.
Braced for a shock
Alarm bells are now ringing. In Beijing, officials and economists are bracing themselves for any external shock that could slow domestic GDP expansion this year still further. Once again, senior officials are stressing China’s need to rebalance its economy by reducing its heavy reliance on exports and investment in favour of domestic consumption. With economic risks abroad, China needs to stand on its own feet.
But the domestic economy is facing some of its own problems, too. Poor capital distribution and bubbles – caused by excessive investment and the improper allotment of credit – must be unwound and deflated. Wage gains intended to stimulate the consumer sector have also become a risk to the economy, increasingly pricing some Chinese industries out of competition with other emerging markets, and even some advanced ones.
China's economic growth is now forecast to slow to just over 8% in the first quarter from 8.9% in the previous one, marking the fifth consecutive quarterly slowdown. That’s an enviable growth rate for developed countries still struggling to emerge from the financial crisis. But it’s likely to put China’s economy on track for its slowest full year of growth in at least a decade. An external shock is not out of question either. The IMF said recently that more failure in the Eurozone, for example, could halve China’s growth this year.
Over-tightening of domestic macro-economic policies, especially those aimed at the real-estate market, could heighten the slowdown. Thanks to stringent cooling measures from the government, with policy makers putting the brakes on lending, property prices are already falling across China. If the dip turns into a crash, the hit to GDP growth would be huge. Patrick Chovanec, a professor at Tsinghua University’s School of Economics and Management in Beijing, reckons a 10% drop in property investment would cut economic expansion to 5.3%.
Fundamentals getting weaker
It all adds up to rapidly weakening Chinese economic fundamentals; and they are emerging much more quickly than the government expected, say some economists. It may be similar to the impact of the 1997 Asian financial crisis. In the years before that catastrophe hit, China had been fighting inflation and looked on track for a soft landing. Instead, a period of crisis and austerity condemned its economy to several years of deflation and considerably muted growth.
Managing things this time may be just as tricky. Government policy is to let growth fall from the double-digit pace of the past decade to about 7.5%, hoping a more gradual easing will foster higher-quality growth. There are signs that the transition is under way. The trade deficit is a sign of things to come. Exports of labour-intensive clothing and shoes fell by more than 2% year-on-year. Higher-end exports are faring better, but the 8.8% year-on-year growth rate of electronics and machinery still marks a deceleration from the 11.5% growth rate in the last three months of 2011. Many believe some short-term pain is necessary evil to ensure long-term gain.
Whether the government would again step in to stimulate the economy is debatable. The last economic Band-Aid, slapped on in 2008, has since run its course. It may have saved the country from a sharp shock then. But it also yielded speculation and poorly distributed loans, which set the stage for an extensive market shakeout. China’s leaders are understandably more cautious this time around.
The net result is an impending economic malaise that has far-reaching consequences for oil markets. The International Energy Agency (IEA) has already curtailed its outlook for Chinese oil demand on the back of weaker economic underpinnings for 2012. Further cuts, in tandem with flagging economic growth, seem inevitable. If China’s economy tanks, domestic oil consumption would, too.
And as China’s oil needs have grown, so has its influence over oil markets. Demand expansion from the country will rise by 3.9% this year, says the IEA, making up around half the extra 800,000 barrels per day (b/d) of global oil demand growth in 2012, more than offsetting sluggish consumption growth, or decline, elsewhere.
But that forecast, which the IEA bases on Chinese GDP growth of a rosy 8.2% this year, may turn out to be optimistic. China National Petroleum Corporation, a state-owned firm, thinks implied oil demand, calculated by adding net fuel imports to refinery throughput, will grow at under 4% – the lowest rate in years – to 9.9 million b/d, as waning economic activity caps fuel consumption.
And China may react to soaring oil prices, too. Imported barrels reached a record 5.95 million b/d of crude in February, up 14.4% on year-ago levels. But that looks like a peak that won’t be surpassed for months as rising prices thin refiners’ margins further just as they put plants into maintenance, curbing demand. Crude throughput at China’s top refineries, say estimates, will drop to a 31-month low in March with daily production nearly 10% lower than in February.
The unknown in all this comes from China’s stock-building programme. Tensions in the Middle East and supply disruptions in Africa, both crucial regional suppliers of crude to China, give Beijing every incentive to stock up now, even if the buying spree puts upwards pressure on already inflated crude markets. China also fears oil trade with Iran will be much more difficult if broader sanctions cut off oil-payment channels to Tehran.
Indeed, oil imports have soared since November, despite the moderation of economic growth. While implied demand hit a record 9.71 million b/d in February, up just 2.2% year-on-year, the crude-import data, excluding imports of refined products and domestic oil output, showed China buying 670,000 b/d more than implied oil demand. This disconnect suggests that Beijing has been diverting crude to newly completed strategic petroleum reserve sites since September. An estimated 17 million barrels of crude, or a daily rate of around 190,000 barrels, has flowed into both commercial and emergency tanks recently finished in the remote Xinjiang region and Gansu province, reported Reuters.
The pattern could increase in coming months. Kang Wu, head of Asia operations at Facts Global Energy, a consultancy, reckons the potential extra demand generated by China adding strategic inventory could amount to between 100,000-200,000 b/d this year. The IEA says some 79 million barrels of new emergency capacity could be seeking crude, equivalent to 220,000 b/d of additional demand.
For now lofty prices and a backwardated market – near-term prices higher than those further along the futures curve – give Beijing every reason to hold off strategic oil buying. Crude import volumes should also retreat in March and April.
For the oil market, though, there remains a paradox. Any slowdown in Chinese economic growth would surely hit oil consumption in the country’s real economy. It would also signal a widening of the economic crisis. An oversold oil market would be ripe for a fall. That, however, would provide the impetus for China to hoard more crude. If crude prices slip off the cliff, China won’t be afraid to use additional commercial or merchant storage to take advantage of deep discounts.