Commodity Online China's GDP growth will slow down from 11.9% in Q1 to 9% in Q4.Lower productivity growth, adverse demographics and lower returns to capital will reduce future potential GDP growth in China to around 9%. The peak is already evidenced in the data: Industrial production has turned and the growth in power, coal, cement, steel and auto production has slowed down. The circulation of money and credit, a major driver of commodity demand, could slow the economy down further, a Bank of America-Merrill Lynch (BofAML) analysis said.
BofAML economists continue to believe that China's economy will rebalance, via more FX flexibility. A stronger currency will likely reduce the current account surplus, in turn reducing Chinese FX reserve accumulation. On our estimates, the impact of a Chinese revaluation varies strongly by commodity. In some cases, a CNY revaluationwould negatively impact consumption growth as a stronger CNY reduces exports and hence GDP growth. Most commodities, however, should benefit from a positive long-run effect, as a revaluation would boost the purchasing power of the Chinese consumer for USD-denominated raw materials.
Chinese government has tightened lending growth, this past weekend, the People's Bank of China hiked the reserve ratio requirement by 50 bp, continuing on its path of tighter monetary policy via quantative measures. Most importantly, China is also tightening its screws on the property sector as it poses a real risk to the economy.
The government is undertaking a series of measures, such as raising the minimum downward payment ratio, to stem property speculation. As a result, sales and property prices are likely to decline further. Growth of fixed investment in real estate will likely slow down too. The Chinese stock market has reacted strongly to the monetary tightening and is now pricing a slowdown in China. Importantly, the government controls both money and loan supply in China. Despite the latest cash drain from banks, BofAML still sees ample supply of credit in the system to support growth.
Which commodities are most exposed to a slowdown? Which commodities are most exposed to a Chinese economic slowdown? China's grip on the commodity sector has clearly intensified over the past years. Today, China is a net importer of every major commodity other than aluminium and steel. For instance, just two years back, China was still a large net exporter of coal. Base metals and bulk commodities are likely to suffer from a cyclical turn-around in China. BofAML estimates, the country makes up at least 40% of global demand, rising as high as 65% in the case of iron ore. By contrast, China's contribution to the global steel and iron ore market was tiny just a decade ago.
Or rather, which ones are not? Equally, China takes up a respectable share of global corn and wheat consumption, at 15-20%. For oil, it makes up a relatively small share of 10% of demand, from 8% five years ago. Since changes in demand matter for changes in prices, we prefer to analyze which commodities have been relying on China for growth. China's contribution to global oil demand growth is much larger, estimated to come in at 21% in 2010 . Still, Chi na has a much stronger appetite for coal and natural gas than for oil, BofAML analysis said.
China has supported global demand during the recession Given that China has led the rest of the world out of the recession, it is not surprising that Chinese demand for commodities has soared even as other countries cut back consumption. In 2008 and 2009, oil demand from countries outside China fell dramatically, to the tune of 0.6 to 1.9 million b/d annually, respectively. However, Chinese demand remained steady and positive, with incremental demand growth doubling in 2009. While the rest of the world saw a 2.5% decline in oil demand, China experienced an 8% increase, one of the strongest growth rates seen in the last five years could lead to marginally higher commodity consumption. Of course in reality, the overall policy mix implemented by the government matters and will ultimately impact how big the influence of these variables is on Chinese commodity demand growth.In addition to oil, Chinese demand saved the day for a range of other raw materials during the recession. China's contribution to the growth in thermal coal demand, in particular, almost entirely made up for the demand destruction experienced elsewhere. Chinese coal imports increased by 20% in 2009 while the rest of the world experienced a 4% decline in demand. Furthermore, China's contribution to global steel consumption growth has also been staggering. Global steel consumption has been on a downward trends since 2006 driven by a slowdown in the US, Europe, and even India. China, on the other hand, has seen double-digit demand growth every year, almost entirely compensating for everyone's losses during 2009.
Chinese oil imports could slow on loan controls Highly leveraged to private consumption, oil demand is clearly influenced by the amount of credit that is spilling around the system. A slowdown in credit issuance tends to negatively impact oil demand growth. For China, where the effect is amplified by the fact that the government has a tight grip on credit issuance, the impact of loan growth on oil import growth is strong and increasing over time, though it is lagged by three months. Interestingly, the impact of a slowdown in credit is twice as bad for oil imports as a slowdown in industrial output. Copper, at the other extreme, behaves very differently given that it is an industrial as opposed to a consumer good. Chinese copper imports tend to correlate much more strongly with the economy than changes in loan issuance, BofAML analysis said.
Coal consumption to be hurt After controlling for GDP, fixed asset investment has a significant impact only on Chinese coal consumption. A slowdown in fixed asset investment would likely reduce the expansion of coal-fired power generation capacity, reducing the fast growth in coal consumption experienced in previous years, BofAML analysis said.
Metals are less exposed to loan controls While all commodities would be adversely impacted by a Chinese economic model that is based less on exports, oil and corn demand would likely suffer the least in that scenario. Meanwhile, loan issuance in China has a strong positive impact on consumption growth of oil, corn and copper, but a negative or nonsignificant impact for most other commodities. In general, copper demand growth seems to be much more exposed to a slowdown in exports than to loan controls, unlike oil demand growth.
Most commodities would benefit from a revaluation Finally, what does a potential revaluation do to the commodity markets? BofAML economists continue to believe that China's economy will rebalance, via more FX flexibility. A stronger currency will likely reduce the current account surplus, in turn reducing Chinese FX reserve accumulation which has been running at a rate of about $400 billion during the past three years. The impact of a Chinese revaluation varies strongly by commodity, BofAML analysis said. Five out of our eight tested commodities show that the substitution effect dominates the income effect. Inother words, a CNY revaluation would positively impact consumption growth as a higher exchange rate improves the purchasing power of the Chinese consumer for USD-denominated raw materials (the price effect). All other commodities show a negative long-run effect. Thus, a revaluation would decrease consumption via the negative impact of the revaluation on exports and hence the economy.
Conclusions (1) China's slowdown in money and credit does matter, particularly to oil; (2) an export slowdown does not matter for oil or agriculture but matters for metals and bulks; (3) a slowdown in fixed asset investment, after accounting for Chinese economic growth, is only important for coal; (4) a trade-weighted FX appreciation.