Thursday, 12 June 2014

NE Asia's Inventory-Related May Export Blip

The surprisingly weakness of NE Asia's May trade data is the result of a long-maturing unwanted inventory build up meeting Chinese financial constraints, and is happening despite the emerging improvement in underlying Western demand.  It's a temporary phenomenon which is likely to be answered later this year by a sharper-than-expected rise in NE Asian output and exports. 

The positive momentum which has been building quietly for months in both Northeast Asia exports and G3 imports, has taken a blow from May's NE Asia trade data.

  • China's exports rose 6.9% yoy, which was only 0.1SD above historic seasonal trends; 
  • S Korea's exports fell 0.9% yoy, which was 0.5SDs below historic seasonal trends; 
  • Taiwan's rose 1.3% yoy, which was 0.7SDs below historic seasonal trends; 
  • Japan's 20-day data points to a likely fall of 6.5% yoy in dollar terms, a full SD below trend. 

Taken together, this suggests NE Asia's exports rose only 2.8% yoy in May on a monthly movt which was 0.3SDs below historic seasonal trend. This is a considerable disappointment, and is a noticeable check to the build-up of momentum which had been emerging.

But it is an unusual weakness, because it is centred almost exclusively in inter-Asian trade. Thus, the real weaknesses in China's exports were in HK down 38.7% yoy, Asean down 5.4%, S Korea down 5.2%, Japan down 1.1%. But exports to the EU jumped 13.4% yoy and to the US exports rose 6.3%.

For S Korea, exports to Asia fell 6.5% yoy, with China down 7.5% and Asean down 9.1%, whilst exports to the EU jumped 23.8% yoy and rose 7.6% yoy to the US.
For Taiwan, the weaknesses were in Thailand down 8% yoy, Singapore down 3.6%,  S Korea down 0.2% whilst Japan rose only 2.6% and mainland China +3.1%. Meanwhile, exports to the UK rose 19.6% yoy, to Germany rose 9% and to the US rose 1%.

The check to inter-Asian trade is also the reason why, though exports were weak, they were much stronger than imports: China's imports fell 1.7% yoy on a monthly move which was half a standard deviation below historic trends; S Korea's imports rose just 0.3% yoy, which was 1.2SDs below trend; Taiwan's imports fell 2.3% yoy,  which was 1.7SDs below trend. Result? Northeast Asia's trade surpluses have burgeoned even as trade volumes slowed noticeably.

Now growth of G3 imports and NE Asian exports usually move in lockstep and have done so for years, with NE Asia's exports growing slightly (and predictably) faster than G3 imports. It is most unusual for them to underperform G3 imports, as the chart below shows – and when it happens it's normally a signal that Western demand is about to slow.  Yet it's happening now, at a time when the performance and prospects for G3 imports are the strongest they've been for two years, and accelerating.

So what's happening? What's happening in Qingdao Port's bonded warehouses gives a big hint. There, the inspectors are on the trail of allegedly fraudulent receipts for inventories of metals,  which are used as collateral to borrowing from Chinese and foreign banks.  There are suspicions that the same stock of inventory has been pledged for multiple loans. This is not what's surprising – frankly, one assumes this is standard operating procedure, with the only person pretending not to know being the banking officer authorising the loan. No, what's important is that the scandal has surfaced now, telling us, as it does, that the loans have defaulted.  The story, then, is that financing conditions are tight – so tight that inventories are being liquidated in order to raise cash.  

It's difficult to get the data to prove this is what's happening generally in China, but perhaps the weekly iron ore inventories tell the correct story: inventories built up sharply during the latter part of 2013 and the first half of 2014, but now appear to be peaking.

If this is the position in the mainland, then it is hardly likely that Taiwan's mainland operations are exempt from the practice or the financial pressure. And if so, one would expect less enthusiasm among Taiwanese suppliers to load their mainland operations with more supplies. 

South Korea provides the clearest example of a long-maturing build-up of inventory which is now reaching its peak. S Korea's inventory turnover index is a near-cousin of the more popular inventory/shipment ratio. As the chart shows, this ratio has been rising steadily since late 2009, and by April this year had reached a new peak. At some point, Korean companies will wish to stop that build-up: the trade data suggests that by May that point had been reached.
The one NE Asian country which quite clearly doesn't have an inventory problem is Japan, where conservative balance sheet management is sufficiently ingrained to provide a vigilant patrol on inventory levels. 

Conclusion? After waiting years for a pick-up in Western demand, and allowing inventories to build-up as they do so, Northeast Asia's industrial base has given up waiting, and, partly under pressure from China's financial constraints, have started liquidating those inventories just as Western demand is finally beginning to return.  For NE Asia this is resulting in a blip in trade. If Western demand continues to emerge, however, it is likely to be revoked later this year with accelerated production and inter-Asian trade. 

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