By Ulf Bergman
The recent news flow coming out of China has been rather sobering, with the latest official manufacturing purchasing managers’ index (PMI) released over the weekend failing to meet analysts’ expectations. The reading was also the lowest since February last year when the country was in the midst of the initial COVID19 wave. While still in expansionary territory at 50.4, the disappointing data may herald a new phase in Chinese economic development with the growth facing more headwinds and greater risks. There was a widespread expectation that the PMI was set for a retreat compared to the previous reading in July, as exports are seen as coming under pressure when large parts of the world are starting to recover from the consequences of the pandemic. In addition, rising commodity prices have contributed to producer prices drifting higher, which has hurt production and profit margins. However, the PMI retreated below the consensus expectation of 50.8, feeding expectations of more fiscal and monetary easings. The official non-manufacturing PMI, which covers construction and services, fared better though and, despite easing, met the pundits’ expectations at 53.3.
Last week’s gathering of the Chinese Politburo also highlighted the leadership’s concerns about the stability of the economic growth, with indications that the economy will continue to be supported by the state. Much of the stimulus is expected to be targeted at small and medium-sized enterprises, which often continue to struggle in the wake of the pandemic and highlight the unbalanced nature of the Chinese recovery. The expectations of additional easing of policies have also sent Chinese bond yields lower. The politburo meeting additionally signalled that fiscal spending through the issuance of local government special bonds will accelerate during the second half of the year to support the economy.
Chinese authorities have also clamped down on several private companies and their business practices in recent weeks, ranging from data integrity and US IPOs to the cost of private education for the children of the burgeoning middle-class. The crackdown on some private enterprises in recent weeks has served as a timely reminder that the Chinese economy is a commando economy, reliant on central planning authorities. Private entrepreneurs have been allowed to flourish despite it is not a market economy, but recent moves by Beijing have served as a timely reminder that investors and private companies operate at the pleasure of the Chinese leadership.
The stronger rhetoric has also spilt over into the steel and iron ore markets. Beijing has attempted to control the surging commodity markets and especially iron ore since May, with limited success for most of the time. However, recent announcements that Chinese steel production should not exceed last year’s level have driven prices down by around fifteen per cent during the last fortnight, to levels not seen since the second half of May. There could also be additional pressure on iron ore prices in the coming weeks and months, as the China Iron and Steel Association has said it expects additional reductions in crude steel production.
Is this the end of the world, as we know it? We will probably be spared such drama, but as it is both prices and emissions that Beijing wants to control there is obviously room for disruptions. However, if the steel production is allowed to match last year’s record output then there is still a considerable amount of iron ore that needs to be shipped to Chinese ports during the second half of the year. While there is not a perfect correlation between iron ore imports and steel production, existing inventories and the building of stockpiles can obscure the analysis, volumes during the first seven months of the year are evenly matched with last year’s. Cargo tracking data from Oceanbolt show that year-to-date only an additional two million tonnes have been discharged in Chinese ports compared to last year. Hence, if last year’s year’s production is allowed to be equalled, the last five months of the year could see average imported volumes of 100 million tonnes.
There is also a degree of contradiction in the ambition to control steel production and a desire to stimulate and support the domestic economy. If there is another round of fiscal and monetary stimulus coming, it could maintain robust manufacturing and construction activities and feed the steel demand. This is also where the rumoured export tariffs may fit in, by keeping the output within the country. Such a development would also see steel production rising in other parts of the world to cater for increasing demand as the economic recovery gathers momentum.
The volumes of iron ore discharged in non-Chinese ports suffered during last year, as the pandemic curtailed demand. Unlike China, where volumes recovered quickly, imported volumes in the rest of the world have recovered slowly and are still below the levels witnessed in the years prior to the pandemic. A combination of global recovery and restrictions on Chinese steel exports could, however, see the recovery in volumes accelerate during the second half of the year.
