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Why China’s industrial activity is important to dry bulk shippers

Xun Yao Chen

Why China is important to the dry bulk shipping industry (Part 1 of 9)

The importance of industrial output

As the world’s largest manufacturer of steel and biggest importer of iron ore, China’s manufacturing can have a significant effect on the dry bulk shipping industry. When industrial growth rises, demand for steel will rise, and so will demand for iron ore. Higher demand for iron ore will push up shipping rates. Because the supply of ships is price-inelastic, meaning shipping companies can’t change supply quickly in the short term due to changes in shipping rates, even a small change in shipments can have a large upward influence on shipping rates. Conversely, when industrial growth is falling, it’s often negative for shipping rates.

China’s industrial output rises to 10.4%

During August 2013, China’s industrial output rose at a rate of 10.4% compared to the same month in 2012. Year-over-year data is used to adjust for seasonality. August’s increase of 10.4% is the highest we’ve seen since March 2012. Industrial output was growing above 12.5% before 2012 because of massive stimulus that was thrown out in 2008 as part of the worldwide initiatives to stop a global meltdown. Unfortunately, that led to a condition of high inflation, in which demand grows more than capacity can keep up with in the short term. Coupled with high food inflation, the government had to raise interest rates and restrict loans to cool its economy in 2011.

Background for China’s industrial growth

As economic activity deteriorated from 2011 to mid-2012, the Chinese government and the central bank stepped in to energize the economy a bit through fiscal stimulus (increased public spending) and monetary stimulus (tools that make borrowing easier and cheaper to businesses and individuals). The once-in-a-decade transition to a new leader group was another reason the government had increased spending to ensure a smooth transition. But since February 2013, soaring housing prices were creating problems again, so the prior government increased down payment for property purchases and raised the tax from profits earned from selling houses before leaving the party. Industrial output growth slowed thereafter.

When the new government took over, its main objective was to implement reforms that would gradually privatize China and accelerate urbanization and consumption growth, while shifting its economic growth reliance away from heavy investment and public-led stimulus. It was willing to sacrifice short-term economic growth for more sustainable long-term growth, setting the economic growth for this year at 7.5%.

The government will try to meet its target

But as economic growth slowed to 7.5% during the second quarter, risk emerges that the government will miss its growth target. If growth does slow further, it will be the first time in a while that the government has missed its annual target. Besides, with unknown amount of state government debt and loans that were borrowed through the shadow market, economic growth can’t slow down too fast and too hard. If it does, and if the government isn’t there to support it, it can slash economic growth momentum.

The good thing is the Chinese government knows this, and long-term growth can’t occur without sustainable short-term growth. That’s why after the People’s Bank of China took steps to rein in shadow banking by restricting credit, thereby raising rates, and economic growth cooled to 7.5%, China announced its intention to stabilize economic growth by accelerating public projects and supporting private companies through tax cuts and other initiatives. August’s industrial output reflects these actions taken by the government.

Outlook and implication for dry bulks

We could see lower industrial output growth over the next few months since industrial output picked up its growth pace in September 2012 because of stimulus, so year-over-year data could be negatively influenced. Yet on the expectation that China’s industrial output growth won’t fall significantly, industrial output won’t likely drive the performances of dry bulk shipping companies in the short term. In the long run, China’s industrial output should continue to grow at a decent pace, despite being lower than it was historically. This bodes positively for dry bulk shippers such as DryShips Inc. (DRYS), Diana Shipping Inc. (DSX), Navios Maritime Partners LP (NMM), Navios Maritime Holdings Inc. (NM), and Safe Bulkers Inc. (SB).

Continue to Part 2

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