China’s New Development Model and Implications of Long-Term Demand for Base Metals
China’s rapid growth over the past ten years has made it the largest consumer of industrial metals (steel, copper and zinc). In 2011, China accounted for close to 50% of global consumption for base metals. However, recent studies have cautioned that this China-driven boom for industrial metals may be nearing its end, as the Chinese government targets slower, less commodity-intensive growth.
China’s 12th Five-Year Plan for 2011-2015 calls for a growth model that focuses on the establishment of a long-term mechanism to boost domestic demand.
This rebalancing away from investment and export-led growth to one based on domestic consumption is expected to reduce demand for industrial raw-materials in the medium term. Nevertheless, its long-term effect is expected to be different from the current global recession characterized by an episodically declining demand for commodities.
The Five-Year plan targets reduced growth in energy consumption by an average of 3-4% per year from 9% in the preceding ten years prior to the plan.
The reduction will be influenced by the projected low target rate of real GDP growth over the next five years – averaging 7% against 9.9% between 1995 and 2010. The reduction in energy consumption will see energy intensity (measured as energy consumption per unit of GDP) decrease by 16% over the same period.
Currently, China is the World’s largest consumer of energy accounting for 20.3% of the world’s energy consumption. However, this is only expected to affect demand for crude oil and coal with demand for petroleum products picking up over the horizon. China’s demand for base metals has been fuelled by rapid expansion in construction activity.
However, as the economic growth momentum peters off, thereby reducing, and concerns that the real estate sector could be a bubble waiting to burst, base metal exposure to the construction industry will inevitably decline. This conjecture is supported by recent estimates which show that China’s demand for base metals could suffer the most growth slowdown induced by tepid activity in the construction industry.
Between 2007 and 2011, annual average growth in demand for copper was pegged at 15%. With the expected growth slowdown, this is set to fall to 6% over the medium term. Growth in demand for steel and zinc will halve to 7.6% and 6% from 14% and 11%, respectively (Barclays Research). Shrinking demand for base metals has contributed to a dramatic fall in prices over the past year. For instance, the price of copper has fallen by 19% since June 2011 following the announcement of plans for a broad rebalancing in 2011 Q1.
Similarly, prices of steel and zinc have declined by 14% and 8% year-on-year over the same period.
However the fall in demand for some metals is expected to be less pronounced. For instance, growth in demand for aluminum is projected to fall to only 12% over China’s Five-Year plan from 18% recorded between 2007 and 2011.
Aluminum is considered a cheaper substitute for copper in power networks and its role in auto manufacturing, and other durable consumer products could still remain attractive. Demand for aluminum may also benefit from planned government investment in the expansion of power grids.
A euro zone crisis induced stimulus in the pipeline
On June 4th, China’s Finance Ministry announced a plan to promote domestic consumption to encourage domestic consumers to pick up the slack coming from slower demand from Europe.
Although the full extent of the stimulus measure has not been explicitly outlined, it is believed to include infrastructure spending, subsidies and incentives for vehicles in rural areas and is estimated at RMB1 trillion or a quarter of the stimulus package in 2008. China’s decision to embark on fresh stimulus measures gave some base metals a boost, albeit temporarily.
For instance, copper edged up by 1% between June 4-6, while steel and zinc prices remained steady.
Nevertheless, it appears China is taking a proactive role in strengthening business confidence, albeit, in a possibly targeted manner. With the euro area remaining under the dark clouds of a Spanish banking debacle, commodity markets will look to China for some relief.
Potential impact scenarios on Africa
There are two possible scenarios emerging regarding the impact of China’s slowing growth momentum on Africa’s commodity dependent economies. The short to medium term implications of lower commodity demand from China dims the outlook on commodity driven foreign direct investment in Africa, especially the mining sector.
Phasing out of investment intensive development model in China could therefore negatively impact sentiment on base metals, irrespective of the short-term tumult caused by the ongoing global recession.
Adding the current stimulus measures to the mix blurs the short term picture on how the rebalancing targets will be achieved and their consequences on Africa’s major commodity exporters. Major players in the global mining industry are revising downwards their capital expenditure plans due to building pressure from shareholders to recoup funds in form of either expanded share buybacks or increased cash dividends.
In May 2012, BHP Billiton and Rio Tinto - two of the largest mining companies in the world - signaled that they are prepared to reign in on spending by either delaying new projects and expansions or cutting expenditure altogether to match cash-flows. Rio Tinto is a major player in the mining sector in South Africa, Namibia, Swaziland, Mozambique and Botswana.
For instance, the company’s Rossing facility in Namibia produces 3% of the world’s uranium and brings in an estimated USD 2 billion, helping the nation stem foreign exchange needs in times of economic fluctuation. Similarly, BHP Billiton has major projects in South Africa with estimated operating costs related to worker compensation in excess of USD 4.8 billion or 12% of the company’s total expenses in 2011.
A reduction in investment could have far reaching social consequences in these countries. In the long term, China’s economic outlook will be determined by the shift in growth driving factors, from export intensity to domestic demand. Broadly, long-term growth in China’s per capita income and that of key emerging economies remains at levels supportive of demand for commodities, and could strengthen as growth in incomes accelerates further (IMF(2012).
In general, commodity exporting African countries are bound to feel the pinch of dependence on commodity (metal) exports although the net impact will largely depend on the extent to which the gap left by China can quickly be filled by other emerging market economies and the ability of African countries to diversify from commodities.