Steeling themselves

Why Chinese steel overcapacity will continue to test global steel producers’ patienceSince 2010, Chinese demand for steel has lagged far behind production and exports (Figure 1). In spite of this, production has remained strong with steel mills taking advantage of low iron ore prices at present. These sustained levels of production have been worrying producers of the metal around the globe as China ships its excess steel abroad. China is already the world’s largest steel manufacturer, in value terms they dwarf the whole of North America and are estimated to be responsible for around 50% of global overcapacity. Steel associations outside of China argue that China is flooding markets and hence driving steel prices down.  As a result of these concerns, eight representatives of steel organisations from around the globe (North America, Latin America and Europe) have lobbied China to alter its recent Steel Adjustment Policy 2015.




Figure 1  | Chinese Steel Exports and Imports, demand and production compared, based 2010
Source | DeltaMetrics 2015


Chinese iron and steel trade is highly correlated with the value of the yuan (and with equity markets across the region). Further, its trade generally is also highly correlated with the Iron and Steel price. Through a state-controlled steel industry, China is able artificially to drive down steel prices and effectively circumvent the market forces which all other global steel industries are susceptible to. The eight steel association representatives therefore hope China will rethink its steel policy for the benefit of the free market and the future of steel trade.

Delta Economics, sees encouraging signs of China reining in its steel exports in future. Between 2010 and 2015 (to the current month), we saw a compound average growth rate (CAGR) in Chinese steel exports of 10.7%. This was compared with 5.3% growth from North America, 1.3% in Latin America and 1.5% in Europe over the same period. However, between 2015 and 2020 we are now forecasting significantly lower CAGR growth in Chinese steel exports of 6.8%. This is compared with growth in steel exports in Latin America (4.2% to 2020), North America (6.2% to 2020) and Europe (2.6% to 2020). It appears, therefore, that China may well be listening to global concerns over its steel overcapacity.

This will not be a quick or easy process, however. It will take years of adjustments to address the Chinese steel surplus. Smaller steel mills within China are most likely to bear the brunt of the readjustment policy with plant closures and redundancies. However, the larger steel mills will be slower to change. Therefore, although our forecasts are showing more encouraging signs for steel producers outside of China, the coming years are likely to severely test the industry.



Nerves of steel  |  Author  |  Jack Harding  |  Analyst and Publications Manager

Under the same Umbrella

Why Hong Kong protests will not have a lasting economic impact  |  Hong Kong’s so-called Umbrella Revolution will worry markets and strategists around the world while it continues; it may even deter a few tourists. There is a potential risk that once a largely younger generation has started to express its counter-establishment feelings, more protests might follow. All of this creates a degree of uncertainty and, in turn, potential for market volatility and reduced trade.

Delta Economics does not see the Umbrella revolution as having a lasting impact on trade or Hong Kong’s role as a financial centre. There has been a downward correction in the Hang Seng since July, although this is more likely to be because of wider economic conditions in Asia than specifically the protests in Hong Kong (Figure 1).



Figure 1  |  Value of Hong Kong’s exports (USDm 2001-2015) vs. Hang Seng Index,
Last Price Monthly, June 2001-September 2014
Source  |  DeltaMetrics 2014, Bloomberg


The correlation between the Hang Seng Index and Hong Kong’s exports is 0.823. This is very high and given a forecast decline in monthly trade export values up to 2015, suggests that the correction that we are currently seeing may have some way to go. However, as can be seen quite clearly from the chart these corrections are cyclical. Delta Economics expects exports in November 2014 will be 1.3% below their 2013 values. By January and February 2015 they will be similar to their levels 12 months earlier – unimpressive growth, but growth nevertheless.
The reason why the protests will have little impact on trade is the very reason why there are protests in the first place: the Umbrella Revolution’s purpose is to point out to the world generally, but China in particular, that it has the right to democracy as a counterpart to the free market and free trade system that it has built. It is not questioning the symbiotic economic and trade relationship with China, merely saying that the logical political consequence of a free market economy is the existence of a democracy.

Hong Kong’s exports to the United States, its second-largest export partner, are just 12% of the US$294bn it is expected to export to China in 2014; while exports to China will grow modestly in 2014, at just under 5%, they are forecast to fall to the US by nearly 3%. This point is reinforced by the fact that it is not just Hong Kong’s exports that are highly correlated (0.817) with the Hang Seng Index (Figure 2), but Hong Kong’s total trade with China as well (0.813).



Figure 2  |  Value of China’s exports to the world and value of Hong Kong’s trade with China (USDm),
June 2001-September 2015 vs. Hong Kong Index, Last Price Monthly, June 2001-September 2014
Source  |  DeltaMetrics 2014, Bloomberg

The Hang Seng moves proportionately with both China’s exports and bilateral trade between China and Hong Kong. Although the correlation is marginally weaker for Hong Kong’s trade with China than it is for either Hong Kong’s or China’s total exports to the world, it is still apparent that the Hong Kong Index appears more dependent on the trade relations between the two countries in the longer term than it does on political relations.

Hong Kong’s export trade is only mildly and negatively correlated with the Hong Kong dollar at -0.525. The Hong Kong Dollar is pegged to the US Dollar and is traded within upper and lower limits (Figure 3). However, a depreciation in the value of the Hong Kong Dollar at present appears to be aligned not just with the protests, but also with broader downward trends in trade (Figure 3).




Figure 3  |  Value of Hong Kong’s exports (USDm), June 2001-September 2015,
vs. USD-HKD Last Price Monthly, June 2001-September 2014
Source  |  DeltaMetrics, 2014, Bloomberg


The correlation between China’s exports and the value of the Hong Kong dollar is 1 per cent stronger, which underscores the fact that the dependency between the two countries works both ways. There is very little correlation between the value of the Shanghai Composite index and either Hong Kong or China’s trade (less than 0.34 in both cases) suggesting that the Shanghai Composite is more of a speculative market that the Hang Seng. However, the correlation between both China and Hong Kong’s exports and the value of the Yuan is extremely high at 0.885 and 0.941 respectively suggesting that China’s currency manipulation may have positive spillover effects for Hong Kong’s trade as well as China’s (Figure 4).



Figure 4  |  Value of Hong Kong and China’s exports (USDbn), June 2001-September 2015 vs. USD-CNY spot,
Last Price Monthly, June 2001-September 2014
Source  |  DeltaMetrics 2014, Bloomberg


Thus far the revolutionary impact of the protests has been limited. Indeed, there are signs that the numbers of protestors are dwindling. However, they have been successful in raising global awareness of the issue of democracy in Hong Kong and there is no guarantee that these protests will be an isolated event.

The protests highlighted the issue of how important Hong Kong is to Chinese and world finance. Markets were unsettled by events and investor confidence was knocked, however briefly. However, it is unlikely that there will be a lasting impact on long-term confidence, a weakening in the rule of law, or even a threat to the free-market and trade traditions of Hong Kong. After all, in the end the two countries are, economically at least, under the same umbrella.