Since the mid-1990s, China’s economic growth rate has been one of the most important determinants of the oil price (and of the gas price too as, historically, 70 percent of this has been derived from the oil price). The vast disparity between the country’s energy requirements to power its economic growth on the one hand, and its lack of indigenous oil reserves on the other, drove the commodities ‘super cycle’ from that decade. This was characterised by consistently rising prices for the key commodities used in its economic growth, including oil, as analysed in depth in my new book on the new global oil market order. As late as 2017, its high rate of economic growth allowed it to overtake the U.S. as the largest annual gross crude oil importer in the world. However, recent data releases from China have raised questions over the degree to which its economy is recovering from the negative effects of Covid, prevalent from 2019 to 2022. Comments last week from officials about further measures to stimulate growth were seen as bullish for oil prices by many traders, but the question is how effective any such measures might be in enhancing China’s economic recovery and driving oil prices higher?
On the face of it, the most recent figures from China appeared encouraging for oil bulls. The big number release last week – second quarter gross domestic product (GDP) – showed growth of 0.8 percent in the April to June period on a seasonally adjusted basis. This was higher than consensus analysts’ expectations of a 0.5 percent increase. On a year-on-year basis, GDP expanded 6.3 percent in Q2: significantly better than the 4.5 percent rise in Q1. However, a more critical look at the figures made less positive reading. GDP did rise 0.8 percent in Q2, above expectations, but it increased by 2.2 percent in Q1. Year on year, it was a 6.3 percent GDP expansion in Q2, but forecasts were for growth of 7.3 percent or better. In sum, it was certainly the highest rate of growth since the second quarter of 2021, but it was starting at the very low base point of comparison last year when there were stringent lockdowns in place across several major economic hubs in China, including Shanghai. At around the same time as these figures were released, an official from China’s National Development and Reform Commission (NDRC) pledged that the country would roll out policies to “restore and expand” consumption without delay. The official added that: “Focusing on stabilising the bulk commodity consumption, improving automobile and electronics consumption as well as optimising consumption environment, we will introduce a batch of practical and effective policies and improve their implementation as soon as possible.”
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This said, there is a limit on the scale and scope of the measures that may be implemented, given the view of China’s President Xi Jinping on the nature of his country’s economic growth. In March, the country’s principal working body on economic growth released the official growth estimate of ‘around 5%’. Xi, though, wants it to surprise on the upside as he regards over-delivering in this context as being key to his ongoing consolidation of power for the coming years. However, he has made clear many times before that he does not want this growth to come in such a way that leads to a spiralling up in inflation and interest rates. This, then, precludes massive fiscal and monetary stimulus packages of the sort seen around the globe after the Great Financial Crisis that began in 2007. The key reason he wants to avoid this is that sharply rising interest rates (that would be needed to keep rising inflation at least at vaguely manageable levels) would bring with them the likelihood of massive debt defaults at corporates and financial institutions across the country.
China’s domestic debt market has been fuelled for decades by a spider’s web of assets and liabilities criss-crossing the corporate, financial institution, state-owned enterprise, and government sectors in on-balance sheet and off-balance sheet loans and obligations. Unofficially, China’s total debt to GDP ratio is anywhere up to 300 percent, up from around 200 percent just five years or so ago. Even according to the People’s Bank of China’s (PBOC) own data, outstanding ‘total social financing’ (TSF) stood at CNY5.98 trillion (USD858 billion) in January 2023. TSF measures overall credit supply to the economy and includes off-balance-sheet forms of financing that exist outside the conventional bank lending system, such as initial public offerings, loans from trust companies and bond sales. These figures look even worse when considering the potential debt hidden in lenders’ off-balance-sheet portfolios of loans that have been re-packaged into ‘wealth-management products’ (WMPs). These products typically offer a high rate of return and were originally targeted for sale to the public until the sales’ focus shifted to financial institutions. Up until very recently these products were effectively unregulated and their issuance continues to soar. Indeed, the stock of Chinese banks’ off-balance-sheet WMPs increased around 200 percent from 2014 to the end of 2022, compared to around 50 percent growth in on-balance-sheet assets during this time.
China’s property market is one sector in which such default threats have become particularly acute in recent years. “And without improvement in the property sector, Beijing will find it challenging to stabilise economy-wide activity,” Rory Green, chief China economist for GlobalData.TSLombard, exclusively told OilPrice.com last week. “Real estate is, of course, closely intertwined with consumption, investment and borrowing, and prices and investment fell further last month, as did developer funding, a leading indicators of future activity,” he added. “Barring a policy surprise at the July Politburo - which is not our base case - the stabilisation of prices and expectations will prove difficult in the second half of this year,” he underlined. Although there are pockets of demand to be seen across the country, and more support is expected, Green believes both its size and efficacy are likely to disappoint. “We think the main driver of easing will be fiscal, with expanded bond issuance, government transfers and lending spurring infrastructure investment and, to a limited extent, consumption,” he told OilPrice.com. “The PBoC will likely cut the required reserve ratio by 25 basis points [bps] and policy rates by 10bps, and property stimulus will be more of the same: targeted lending and regulation reduction,” he added.
In addition to this in terms of oil price direction from here is that all these measures fall within the operational parameters of China’s new economic phase, which is being led by household consumption, mainly services, following three years of intermittent mobility restrictions during the Covid period. In this oil price context, it is apposite to note that transportation, as a prime example, accounts for just 54 percent of China’s oil consumption, compared to 72 percent in the U.S. and 68 percent in the European Union. In 2022, net oil and refined petroleum imports were eight percent lower by volume than the pre-Covid peak, with infrastructure and export-oriented manufacturing partly offsetting lower mobility and less property construction. “The certain outcome is an increase in oil demand - we estimate a five to eight percent increase in net import volumes – but this is unlikely to cause oil prices to surge,” Green highlighted. “This is especially true as China is buying at a discount from Russia,” he concluded.
By Simon Watkins for Oilprice.com
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