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Trimming inventory needs a recovery in real demand
By Alaistair Chan |
September 5, 2012, Wednesday
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Print Edition
Print Edition
THERE has been a spate of reports recently on the buildup of inventories among Chinese producers. To give a few examples, commodities such as coal, copper, cotton and rubber are piling up in China's ports and unused car parks and granaries, and prices have fallen accordingly. Automobiles, toys, kitchen sinks, and other manufactured goods are piled high in warehouses across the counatry.
This has affected foreign manufacturers as well. US machinery producer Caterpillar is shifting unsold tractors and other equipment in China elsewhere around the world to sell. Japanese industrial production fell in July even as inventories rose, with production of tech components noticeably weak.
Iron ore inventories are at a record high and prices have fallen dramatically. The Qingdao iron ore benchmark has fallen 35 percent so far this year to below US$90 per ton, the lowest since the end of 2009. This is below the US$120/ton reservation price, which is the estimated price at which costlier to produce domestic supply would exit the market. Meanwhile close to 100 million tons of iron ore sits in ports around the country.
Some of the increase in inventories may be overstated. Iron ore has been piling up in record amounts in ports across the country, but this partly reflects the creation of increased storage capacity. This is why importers have steadily added to inventories since 2007, apart from a drop during the 2008 global financial crisis.
Nevertheless, it seems that many Chinese producers were overly optimistic in estimating how quickly stimulus actions would reignite demand. Imports continued at a relatively buoyant pace and prices of manufactured goods were not cut. This has led to rising inventories and falling profits.
In its latest Article IV consultation, the International Monetary Fund estimated that the Chinese economy was running only at around 60 percent of capacity. This may be overstating matters - by its calculations, China was using only 80 percent of capacity before the 2008 global financial crisis when inflation was running close to 9 percent year on year - but it shows that there is a lot of slack in the economy that could lead to deflation pressure.
Four factors
A combination of four factors will be required to eliminate excess inventory: lower purchases of inputs, slower production, lower prices, and higher demand. The first three are slowly occurring. Purchasing managers at various manufacturers note that their purchases of inputs and raw materials are falling. Industrial production growth is still decelerating, and consumer and producer price pressures are nonexistent.
Unfortunately demand, both domestic and external, is yet to recover. Our tracking model puts China's third quarter GDP growth at 7.7 percent, which is mildly higher than the 7.6 percent recorded in the second quarter, but the risks to this forecast are on the downside.
This has affected foreign manufacturers as well. US machinery producer Caterpillar is shifting unsold tractors and other equipment in China elsewhere around the world to sell. Japanese industrial production fell in July even as inventories rose, with production of tech components noticeably weak.
Iron ore inventories are at a record high and prices have fallen dramatically. The Qingdao iron ore benchmark has fallen 35 percent so far this year to below US$90 per ton, the lowest since the end of 2009. This is below the US$120/ton reservation price, which is the estimated price at which costlier to produce domestic supply would exit the market. Meanwhile close to 100 million tons of iron ore sits in ports around the country.
Some of the increase in inventories may be overstated. Iron ore has been piling up in record amounts in ports across the country, but this partly reflects the creation of increased storage capacity. This is why importers have steadily added to inventories since 2007, apart from a drop during the 2008 global financial crisis.
Nevertheless, it seems that many Chinese producers were overly optimistic in estimating how quickly stimulus actions would reignite demand. Imports continued at a relatively buoyant pace and prices of manufactured goods were not cut. This has led to rising inventories and falling profits.
In its latest Article IV consultation, the International Monetary Fund estimated that the Chinese economy was running only at around 60 percent of capacity. This may be overstating matters - by its calculations, China was using only 80 percent of capacity before the 2008 global financial crisis when inflation was running close to 9 percent year on year - but it shows that there is a lot of slack in the economy that could lead to deflation pressure.
Four factors
A combination of four factors will be required to eliminate excess inventory: lower purchases of inputs, slower production, lower prices, and higher demand. The first three are slowly occurring. Purchasing managers at various manufacturers note that their purchases of inputs and raw materials are falling. Industrial production growth is still decelerating, and consumer and producer price pressures are nonexistent.
Unfortunately demand, both domestic and external, is yet to recover. Our tracking model puts China's third quarter GDP growth at 7.7 percent, which is mildly higher than the 7.6 percent recorded in the second quarter, but the risks to this forecast are on the downside.
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