China Credit Stimulus Pushing Steel Demand Until 1st Half 2017

China has been an economy that has faced significant headwinds, with multiple predictions of doom and gloom failing to materialize. The notion that China was causation for commodity deflation was a popular meme, but steel consumption is picking up. A Goldman Sachs report looks at steel demand and tracks how government credit stimulus efforts impact steel demand. The report tracks stimulus and its impact based on how it is injected into the economy.

Credit Stimulus

Credit Stimulus – Steel demand expected to remain strong, with stimulative impact depending on delivery mechanism

Steel demand out of China should remain strong until at least the first half of 2017, a December 13 Commodities Research report from Goldman notes.

There are two primary methods that the Chinese government has introduced stimulative credit into its economy. One method, through infrastructure spending, creates a stimulative impact that can sometimes take longer to filter into the system but lasts longer.

In a research report titled “China on Demand: The long shadow of credit stimulus,” notes that credit stimulus can be expected to last for four or five years when injected through infrastructure plans. This is because it can take longer to build railways, subways and other steel heavy projects.

Compare this to housing credit stimulus, which the report estimates can find its way into steel demand quicker but only last one to two years. Stimulus overall becomes apparent during the third quarter after the initial credit injection, but becomes statistically insignificant from the fourth quarter onward.

Infrastructure stimulus has different lag impact that real estate stimulus

“Credit stimulus casts a long shadow over metal demand,” and that demand “remains stronger for longer if credit stimulates infrastructure vs. property investment,” The report concluded. “The lead/lag relationship between credit and steel consumption can be different, as infrastructure projects tend to take much longer to complete than housing units. Such differences are important because it means that the profile of credit boost to steel consumption may vary depending on where the government directs credit flows.”

For Chinese steel demand, the credit stimulus that was input into the system earlier in the year is starting to have an impact. If the stimulus faucet were to be turned off to near 2014 lows, the support has at least a 6-month impact, the report estimated.

Sometimes the stimulus can artificially overheat a market.

China’s latest property market boom, driven in large part by central government planning, has led to local governments announcing purchase restrictions over the past few months. Ironically, this is leading to government central planning being used to clean up the mess from government central planning.

Goldman says that property restrictions could be an investment headwind and “clearly a risk to watch.”

There is also policy uncertainty that is a risk, that is not exclusive to China. “While potential fiscal stimulus in the US and improvement in activity globally are lifting risk assets and inflation expectations, policy parameters under the Trump administration remains unknown,” the report said. “China credit and capital outflow risks, which depend crucially on government policies, could resurface in 2017.”