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Commodities

China GDP shows action needed on industry zombies, currency: Russell

LAUNCESTON, Australia (Reuters) - - The trick with big, important numbers like China’s gross domestic product (GDP) is not working out what the data tells us, rather it’s what it doesn’t.

An employee works at a factory of Dongbei Special Steel Group Co., Ltd., in Dalian, Liaoning province, China, December 5, 2015. REUTERS/China Daily

China’s economy met market expectations by expanding 6.8 percent year-on-year in the fourth quarter of last year, which put full-year growth at 6.9 percent, down from 7.3 percent in 2014 and the slowest pace of expansion in a quarter of a century.

Other economic data released on Tuesday came in slightly below market forecasts, with December industrial output up 5.9 percent year-on-year, retail sales up 11.1 percent and January to December fixed-asset investment up 10 percent.

What the data shows is that the trend of a slowing Chinese economy remains intact, as does the slow and somewhat painful process of shifting the drivers of growth from heavy industry and construction to consumer activity.

It’s now virtually an accepted market fact that China’s economy will continue down this path in 2016, something top officials have acknowledged.

So what are the GDP and other numbers not telling us?

The main thing is exactly what steps Beijing will take and when they will be taken in order to ensure that growth doesn’t fall too far this year.

The market will be looking to further monetary and fiscal easing as the headline act in official efforts to prop up growth and ease the transformation process.

But given that China’s slowing growth is largely a result of debt-driven overcapacity in many sectors, it’s likely that monetary and fiscal policy won’t be enough.

What would seem key to China’s prospects of a second half recovery is decisive action on structural reforms, and dealing with excess capacity in key heavy industries is the main area to target.

Industries that need action to purge surplus capacity include steel, aluminum, coal, cement and shipbuilding, all of which happen to be key consumers of major imported commodities.

At the UBS Greater China Conference in Shanghai last week, the bank’s chief China economist Wang Tao said she believed the government would have success this year in tackling overcapacity.

However, when the conferences delegates were asked to vote on whether they shared this optimism, the overwhelming response was that Beijing would make little to no significant progress on restructuring, merging or closing state-owned enterprises (SOE).

NEED TO KILL ZOMBIES

Many of these companies are referred to as zombies, insofar as they continue producing even though they are loss-making and saddled with enough debt that it would be impossible for them to trade themselves to sustainable profitability, even if the prices of the commodities or products they produce increased.

The other key issue raised at the conference was whether the authorities will be able to manage the yuan exchange rate, or whether they will struggle to prevent a weakening of more than 10 percent against the U.S. dollar in 2016.

Both the issue of reform of industries with excess capacity and the path of the yuan will be key for China’s commodity imports.

A significantly weaker yuan will discourage commodity imports and may lead to the reduction of stockpiles, particularly for those commodities with existing elevated inventory levels, such as copper and iron ore.

The impact of restructuring the SOE sector will be harder to quantify, as in theory it will lead to lower output and therefore a reduced requirement for natural resource inputs.

But it’s more complex than that.

Rationalizing domestic mining may result in lower output of iron ore and coal, thus opening the door for increased imports of cheaper supplies, especially from top exporter Australia.

Shutting excess steel capacity may not lower actual output much, rather it will lower the cost curve for China’s production, which in turn may make exports more competitive.

The same argument could be made for aluminum and copper smelting, which also stand to benefit from lower overall production costs, rather than lower actual supply.

However, the start of a recovery in commodity prices is likely linked to the removal of excess capacity, particularly in China.

This may come initially at the cost of lower imports of key natural resources, which in turn should drive rationalization of output outside China.

But overall, it will key to watch what Beijing actually does to reform zombie SOEs, and if reforms are forthcoming, working out how long they will take to make a difference.

(The opinions expressed here are those of the author, a columnist for Reuters)

Editing by Joseph Radford

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