Chinese overcapacity is back. That’s bad news for manufacturers world-wide—and for China’s mounting debt problem.
China’s producer prices rose just 0.9% in December, slumping from 2.7% in November as global oil prices fell sharply late last year. Most concerning is what lies behind the headline figures. Iron and steel sector producer prices fell for the first time since 2016. The decline in the auto sector PPI deepened. And the nonferrous metals PPI logged its fourth straight month in negative territory.
Just a few months ago, many analysts were convinced China had conquered its industrial-deflation problem, thanks to an aggressive campaign to shut factory capacity—mostly private-sector owned—in 2016 and 2017. That helped push global material prices back higher in 2017, as well as profits at iconic American companies such as U.S. Steel.
But that campaign coincided with big stimulus, which stoked demand for China’s property, infrastructure and automobile sectors, muddying its impact. The verdict is now in: Beijing’s “supply-side reforms” helped reduce global overcapacity for a while, particularly in the steel industry. But they probably weren’t deep enough to stave off a significant decline in global material prices, now that China’s economy is weakening and the benefits of previous stimulus efforts have mostly worn off.
In fact, the ugly PPI data confirms what has been evident for several months. Profits in the Chinese auto and nonferrous-metal sectors were down 6% and 17%, respectively, in the first 11 months of 2018. And new orders for manufacturers overall are once again growing much slower than production—as in 2014 to 2016, when China was mired in industrial deflation.
One relatively bright spot is the fact that the steel sector—China’s second- most indebted by the end of 2016—is still in reasonable shape. In contrast to 2015, there were no new steel company bond defaults in 2018 excluding previous delinquents, according to data from Wind. Capacity utilization in Chinese steel mills was holding up as of the third quarter of 2018. By contrast, sectors such as autos and chemicals logged steep falls. Iron and steel profits year to date were still up 50% in November compared with the same period in 2017.
Still, matters are likely to get worse in 2019—meaning China debt worries could soon start spooking markets again. And global industrial companies are in for a rough ride: Chinese capacity utilization tends to move tightly both with metals prices and purchasing managers indexes globally.
By Nathaniel Taplin
Wall Street Journal