Zombie economics

Author Tom Reed

Cheaper oil is a shot in the arm for the global economy, the IMF says in today’s updated World Economic Outlook (WEO). But as in zombie movies, “a shot in the arm is not always enough,” IMF chief economist Olivier Blanchard notes.

Cheaper oil is a shot in the arm for the global economy, the IMF says in today’s updated World Economic Outlook (WEO). But as in zombie movies, “a shot in the arm is not always enough,” IMF chief economist Olivier Blanchard notes.

In particular, the IMF is worried about China — slashing its outlook for the country’s GDP growth this year by more than any other major economy except Italy (faint praise, indeed). Even the eurozone, as a whole, should fare better than China in 2015, relatively speaking, the IMF reckons. It has downgraded the euro group’s GDP forecast by a mere 0.2 percentage points, compared with GDP forecasts in October’s WEO. China’s GDP will grow 0.3 percentage points more slowly than expected, at 6.8pc this year.

Data out today showed Chinese GDP grew at 7.4pc last year, its slowest pace since 1990, Standard Chartered bank says. This was also, for the first time, lower than the government’s own guidance of 7.5pc.

But why so concerned? As a major energy importer, China should benefit from falling energy prices. As much as 5-10pc of China’s GDP growth in 2015 will be the result of lower oil prices, according to IMF modelling. Many of China’s long-term gas contracts are indexed to oil, and are coming down too, albeit slowly. And the price of coal, which powers almost all Chinese power plants, has been falling since mid-2011. China has benefited too from a rise in the value of local currency the renminbi (yuan) against the US dollar, which has shaved another 5pc off the cost of crude since 2011.

Global crude prices have more than halved in the past six months. And, with Opec sticking to its guns, they are likely to have to stay lower to rein in US tight oil production, forecasters such as Argus Consulting Services, Goldman Sachs and Merrill Lynch argue. Goldman Sachs suggests at least a year or two of depressed prices (see Argus Global Markets, 16 January, p1).

China began ramping up crude purchases in 2013, as the cost of deliveries slipped below $100/bl. Imports soared by over 10pc in 2014. But much of China’s record crude imports last year remains unused in storage tanks, because demand for fuel is weaker than it used to be.

China’s problems are partly fiscal. Emerging economies are seizing the opportunity presented by falling prices to cut energy subsidies. Beijing has hiked consumption taxes on gasoline and diesel since October and reduced rebates for LNG imports, so consumers are seeing fewer benefits of falling oil prices.

Its woes are also structural. Chinese total debt levels have soared since 2008, to an estimated 250pc of GDP by mid-2014. The government wants to get debt under control and allow bad companies to fail. This month, it allowed one local property developer, Kaisa, to miss a dollar bond coupon payment.

In these uncertain times, state-owned banks would far rather lend to local government investment funds than the mom-and-pop firms that would do far more to enrich China’s fledgling consumer class. A slowdown in infrastructure investment in the third quarter of last year suggests Beijing is taking the painful but necessary steps towards “rebalancing” towards consumption, the IMF says. But state-owned banks still plough far too much cash into projects intended to generate demand for goods and services. Often, these prove white elephants.

Government-backed developments also crowd out funding for the private sector. Manufacturing is in the doldrums, reducing the need for diesel that fuels China’s truck fleet. The cost of capital to private firms ranges from 10pc through official channels — more than double the official 4.9pc rate at which state-owned firms can borrow — to a punitive 20-30pc from loan-shark stopgap lenders.

Provincial banks are unwilling to let China’s private sector “teakettle” refineries fail because many owe hefty sums. Their creditors prefer teakettles instead to churn out products despite negative refining margins (see Argus China Petroleum, 10 July, p8). But difficulties securing trade finance have all-but driven private-sector companies out of products trading, to the benefit of state-owned firms ChinaOil and Unipec.

China’s crude imports look likely to continue growing this year. Falling prices and massive storage capacity additions are likely to ensure that. The issues to watch are whether falling oil prices lead to a rebound in diesel use by the manufacturing sector in China and continued growth in consumer demand for gasoline — or whether crude will continue to be pumped into storage tanks, as it was in 2014.

China has begun the painful process of reform, but it is only part-way along that path. The hardest steps are yet to come, and large sections of its economy appear to be shuffling lifelessly along.

For more information please contact OilBlog@argusmedia.com

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