Price Fall Dims Inflation

Jun. 24 - The drop in bulk commodity prices signifies a shift in the direction of the Chinese economy

 

Considered a "weathervane" for the state of the economy, the prices of bulk commodities in China have been on decline since the second half of 2012 and show no signs of a turnaround.

 

According to the Mysteel Bulk Commodity Price Index of China (MyBCIC), in May the index stood at 1,060.65, a year-on-year decline of 8.3 percent and a drop of 1 percent on a monthly basis. What follows the declining index is sluggish economic growth.

 

The fall in bulk commodity prices, which serve as materials for industrial production, is pulling down the producer price index (PPI). According to the National Bureau of Statistics (NBS), in May the PPI dropped by 2.9 percent from a year ago, the lowest within the past eight months. On a monthly basis, the index declined by 0.6 percent. In the January-May period, the PPI dropped by 2.1 percent year on year.

 

Jiang Shengli, chief analyst on bonds and the macroeconomy with Haitong Securities Co Ltd, says the PPI has kept falling for 15 months, and the trend will soon affect retail prices. In May, the growth of consumer price index stood at 2.1 percent, lower than market expectations. Jiang says the price fall in the production sector rouses concern in the market. It indicates that production capacity is excessive and market demand is inadequate.

 

Investment has also been declining. According to the NBS, in the first five months of the year, growth in fixed assets investment was 0.2 percentage points lower than growth in the first four months, and private investment growth dropped by 0.1 percentage point over a year ago. Both private and State-owned capital has become less enthusiastic about making investments.

 

Such pessimism has spread to international financial institutions. On June 14, Morgan Stanley cut China's 2013 GDP growth forecast from 8.2 percent to 7.6 percent, following similar predications by the United Bank of Switzerland and Barclays Bank.

 

Hu Yuyue, a professor with the Beijing Technology and Business University, thinks China's bulk commodity prices will continue to fall, and with that the Chinese economy will unlikely resume double-digit growth.

 

The public should not worry about sluggish economic growth reflected in the fall of commodity prices, says Hu, because the drop has a positive side: Consumers, suffering from the pains of previous price hikes, can breathe a sigh of relief.

 

During the 12 years since China's accession to the WTO, bulk commodity prices on the global market have risen rapidly while the Chinese economy has also witnessed rapid growth. During this period, China's demand for commodities accounted for 70 percent of the world's total, and its thirst for iron ore and coal accounted for 80 percent. Although China has become the biggest buyer of bulk commodities, it holds no pricing power because the market belongs to sellers.

 

Hu believes the golden era for bulk commodities has now ended, with the reason being the market has changed from a seller's one to a buyer's one for many raw materials. Australia is a major supplier of iron ore to China, whose steel companies had to go through tough negotiations with Australian iron ore companies with few results. But this year, the situation has changed and the contracted sales volume of iron ore is falling.

 

Mediocre economic performance has curbed the prices and demand for bulk commodities in China and more drastic decreases are expected, says Hu. Among various commodities, the price fall of crude oil has wide-ranging significance. Since crude oil is an important "weathervane" in the market, its price fall will further pull down the prices of other commodities such as coking coal and steel billets, which have already been falling.

 

Xiang Songzuo, chief economist at the Agricultural Bank of China, says the central bank may face a predicament in formulating its monetary policy. The central bank may further relax its monetary policy to cope with commodity price falls with the aim of preventing an economic slowdown, but that may encourage speculative activities and steer the economy toward inflation.

 

Price drops of upstream products will increase the demand and facilitate recovery of the real economy, according to Xiang, thereby curbing the pressure of inflation. He hopes the central bank can maintain its present monetary policy and not make any adjustments simply because of the price drop in commodities.

 

Bulk commodity prices in the international market have been falling throughout the year, said Zhang Xiaoyu, a researcher with the Ministry of Commerce. By the end of May, Brent crude oil prices and Dubai crude oil prices had fallen by 10.8 percent and 8.3 percent respectively, and the price of Australia BJ steam coal had fallen by 7 percent; wheat and corn prices at the Chicago Mercantile Exchange fell by 7.6 percent and 4.9 percent respectively; six non-ferrous metals at the London Metal Exchange had gone down by 10-15 percent, while gold and silver prices at the New York Mercantile Exchange had fallen by 17.8 percent and 27.4 percent respectively.

 

The global economic crisis has made countries around the world reflect on their growth models. Developing manufacturing and service industries of low energy consumption and low carbon emissions have become a global trend and will tremendously impact future demand for bulk commodities.

 

However, the market faces the conflict that the supply of capital goods is sufficient in the short term but resources are scarce in the long term. In recent years, low interest rates and the scramble for resources have stimulated investments in energy and mineral resources and rapidly increased production capacity in these fields. This has alleviated short supply in previous years and even caused excessive supplies of some commodities.

 

At present, capital liquidity offers less support for the commodity market, weakening the impetus for prices to soar just as they did in the past few years. Stimulating economic growth has become the top priority for many countries, and unless the real economy sees continual and remarkable improvements, a relaxed monetary policy is unlikely to change. However, various economies must balance their moves to slash debt, reduce deficits, control inflation and maintain economic growth, and are therefore unlikely to release liquidity on a large scale. On the other hand, quantitative easing is becoming less effective in influencing the commodity markets, and the bulk commodity market has been less attractive to the capital markets.

 

"For the above reasons, in this year and the next bulk commodity prices will see neither sustained growth nor a significant drop. Prices will fluctuate frequently, but the long-term tendency is positive," said Zhang.

 

This indicates that in the coming two years, although a price fall will continue in China, the economy won't run into a hard landing.