According to a report issued by ‘China Beige Book’ (CBB), corporate and industrial borrowing in the third quarter of 2018 surged to the highest level since 2013 and that deteriorating cash flows indicate many firms may have directed this credit to plugging payment gaps, rather than making further investments or replacing existing debt.
‘Manufacturing is under fire. The sector’s multi-year rally has given way to declining revenue and sharply declining profit growth,’ CBB said in a report cited by Bloomberg – adding that the explosion in corporate borrowing is not being captured by official government statistics and domestic orders are not making up for the drop in exports.
The report was issued as the US Administration gets ready to impose the largest round of trade tariffs so far, targeting $200 billion worth of goods bound for the US market, due to take effect today.
CBB points out in its report that the plight of the Chinese manufacturing sector is occurring even before any meaningful American tariffs have been imposed. ‘Absent a fall trade deal, this situation will likely deteriorate. The pace of borrowing — at 41 percent of firms, the highest since 2012 — sure smells a lot like panic,’ CBB writes.
China’s property and infrastructure market, often dubbed ‘ the most important market in the world’, is however showing similar signs of debt-stress as that of the manufacturing sector. ‘Recent commentary has suggested that Beijing could combat U.S. tariffs by stimulating property. The third quarter’s performance suggests this approach is not viable’, writes CBB.
Fiscal deficit reduction to speed up deleveraging in its financial sector has been a key objective of the Chinese Government since the mini-crash of 2015. However, the authorities have been trying to crack down on the shadow-banking sector, tighten credit, implement risk controls, and make borrowing more expensive. This does not appear to be working. Given the latest indications of large-scale stress in the manufacturing and construction sectors, conditions are ripe for a complete U-turn and a return to stimulus fuelled growth in capital expenditure.
Last week, Reuters reported that The National Development and Reform Commission (NDRC), the top state planner in the country, would ramp up investment in infrastructure, as well as in agriculture, poverty alleviation and environmental protection. It also said it would speed up construction on infrastructure projects that have already been approved. Steel consumption from infrastructure projects accounted for nearly 20 percent of total usage of the commodity last year.
CBB states in their report that ‘The debate over deleveraging is becoming passé, – more salient is whether fear of a progressively weakening economy means a return to old school fire-hosing.’
Such a U-turn would lend substantial support to the market for transportation of Iron Ore from Australia and Brazil. Iron Ore is mostly carried on the largest dry bulk vessels known as Capesize, (they have to transit via Cape of Good Hope as they are too deep for the Suez Canal) and Very Large Ore Carriers (VLOCs).
The Capesize market has recently corrected off highs reached in August, but with added Chinese stimulus of fixed asset investments, could very well see new highs going into October with the benchmark C3 route from Brazil to China possibly exceeding $30 per tonne, up from just $13 per tonne in April.
With Golden Week holidays in China next week, ship owners and operators now have to consider how soon the implications of both an escalating trade war and a deteriorating corporate environment will cause the Chinese government to pull the stimulus trigger again. The futures market is betting on November.