China’s factories are starting to hum again, but executives are now worried that the rebound could falter on weak demand at home and abroad.
Justin Yu, a sales manager at Zhejiang-based Pinghu Mijia Child Product Co. that makes toy scooters sold for American retailers, is among those seeing their order book improve from the depths of the coronavirus lockdown, but remain well below normal.
“We are seeing more orders coming in this month as we get closer to our normal peak season,” Yu said. “But our orders are still 40-50% lower than last year.” The factory’s production capacity is running at about 70% to 80%, and Yu is making to order to avoid any build up in stock.
The disconnect between China’s recovering production and still dormant demand had shown up in data revealing a rise in inventories, though the latest figures show that easing. The worry remains that sustained overproduction will lead China’s factories to keep cutting prices, compounding global deflationary headwinds and worsening trade tensions, before they eventually cut back on production and therefore jobs.
“The supply normalization has already outpaced demand recovery,” said Yao Wei, China economist at Societe Generale SA. “In other words, the recovery so far is a deflationary recovery.”
Purchasing manager index figures for May underlined the slow nature of the recovery, with the manufacturing outlook slipping back.
Given the weak export outlook, manufacturers such as Fujian Strait Textile Technology Co. are switching their business models to target the home market. It used to sell 60% of its products to Europe and the U.S. before the coronavirus crisis wiped out those sales. Now, Dong Liu, the company’s vice president, is looking for opportunities at home.
“Our company executives have started to visit the local market to make more potential clients know about us,” he said. “Since May 26, we have been producing 24 hours everyday at full capacity. All the inventory has already been sold and we’re rushing to make goods.”
But the domestic strategy isn’t without its challenges. While China’s consumers are largely free to resume their regular lives as fresh virus cases slow to a trickle, they just aren’t spending like they used to.
Retail sales slid 7.5% in April, more than the projected 6% drop. Restaurant and catering receipts slumped by 31.1% from a year earlier, after a 46.8% collapse in March.
What Bloomberg’s Economists Say…
“Although demand conditions are improving on the margin, they will still take a long time to recover to where they were before the virus crisis. Investment is picking up, domestic consumption improving and external demand is less bad than it was.”
— Chang Shu, Bloomberg Economics
In Zhenjiang, Jiangsu province, Melissa Shu, an export manager for an LED car lighting factory, said although orders are steadily improving, there’s no sense of urgency from her clients and the outlook remains uncertain.
“We’re just making goods slowly,” Shu said. “We are worried about the coming months.”
Some producers may be hoping for a real-life enactment of Say’s law, a part of economic theory which suggests that ultimately supply will create its own demand, as long as prices and wages are flexible.
Another scenario is that industry self corrects, according to UBS Group AG’s Chief China Economist Wang Tao. She points to strong steel production during the depths of the coronavirus lockdown, even when demand was weak. Higher inventories means that even as demand recovers, steel production won’t show much of a pick up. And once producers know that orders are falling, they will adjust output.
“I do not think supply will outstrip demand for long – once inventories build up, or producers know orders are falling, production will come down as well,” she said.
That could pose other problems though, especially as unemployment rises. Premier Li Keqiang in a press conference on Thursday highlighted job creation as a critical priority for the government.
The urgency to create jobs may mean there’s even less likelihood of a shake up of state owned companies in the heavy industrial sectors that have historically fueled excess production.
The disconnect is already clear in data points that show, for example, stronger coal consumption by power plants and rising blast furnace operating rates by steel mills, while at the same time gauges for property and car sales are improving more slowly. That combination will drag on China’s growth over the coming months, according to economists at Citigroup Inc.
The problem for China’s industrial sector — due to its massive output — is that it really needs both local and global demand to be strong. If both are weak, it’s clearly a dire outlook. But if local demand recovers and global demand doesn’t, there are still problems.
“At the end of the day, China’s economy is driven by demand and right now there is no demand,” Viktor Shvets, head of Asian strategy at Macquarie Commodities and Global Markets, told Bloomberg Radio.
A scenario where manufacturers capacity originally dedicated to the export market is retooled to produce for the home market instead would still lead to overproduction. Then the supply-demand mismatch would end up adding to deflationary pressures and a pose fresh headwinds to economic growth, according to Bo Zhuang, chief China economist at research firm TS Lombard.
For now, China’s factory owners are hoping it won’t come to that.
Grace Gao, an export manager at Shandong Pangu Industrial Co. that makes tools like hammers and axes — around 60% of their goods go to Europe — is seeing orders come in as her clients get up and running again. But even as things pick up, Gao remains hesitant to call a full recovery.
“Our clients are facing unprecedented problems,” she said. “It’s still hard to estimate when we’ll get back on our feet.”
This article was originally published on finance.yahoo.com/news/.
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