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Analysis: Property construction set to underpin Q3 steel demand for China

China's property sector looks set to be the country's major driver of steel demand in the third quarter as domestic manufacturing continues to struggle and infrastructure growth is unlikely to accelerate from the levels seen at the start of 2019 when Beijing unleashed liquidity into the system via local government bonds.

However downward pressure remains on China's economic growth prospects, with the recent escalation of the US-China trade dispute casting a shadow over major steel-consuming manufacturing industries such as vehicles and auto parts, machinery and some home appliances.


China's economic data for April was weaker than the market had expected, especially for fixed asset investment in manufacturing and total consumer goods retail sales.

Recent manufacturing data for May was also weak, with the National Bureau of Statistics' PMI coming in at 49.4 points, indicating the sector is technically in contraction.


Fortunately for steel demand, China's property sector has been robust to date in 2019, while infrastructure construction has also picked up steadily this year. The two sectors combined account for more than 50% of China's total steel consumption.


With construction activity having entered its seasonally slower period, Chinese steel prices will come under pressure from a lack of demand and soaring steel output in the next couple of months. However, the property sector is expected to remain strong for the remainder of the year given China's proactive monetary measures, which could see the steel market recover in Q3 when construction picks up again.


The outlook is less certain for manufacturing, which some steel market participants believe may bottom out in Q3 before starting to improve.


Consumption of consumer goods has slowed due to China's deleveraging campaign that started in early 2018. The ongoing trade dispute with the US has compounded bearish consumer sentiment and undermined China's real economy at a faster rate in 2019 than in 2018 in the wake of US tariffs imposed on Chinese goods on September 24 last year and raised on May 10.


In order to boost consumption and offset US tariffs, China introduced proactive monetary measures, such as reducing reserve requirement ratios (the amount of cash banks need to keep on hand) four times in 2018 and twice to date in 2019. Fiscal stimulus has also been stepped up, from speeding up government spending to cutting value added tax from 16% to 13% on April 1.


But so far, little improvement has been seen on the consumption side, as April's economic data showed.


The biggest dent was due to retail vehicle sales, which fell 2.1% on year in April. Both auto output and sales slumped by 15% on year in April, accelerating from 3% and 5% year-on-year decreases in March, respectively.


Some steel market participants said vehicle output and sales would continue deteriorating in the short term given soaring vehicle inventories and depressed demand, especially for passenger cars.


One steel mill official said the car market was trying to destock through discounting. He said auto sheet profit margins were lower than margins for ordinary carbon flat steel, as car manufacturers had been clamping down on steel purchase prices. His company has already cut back auto sheet production.


China had set out to stabilize vehicle consumption in 2019 by supporting new energy vehicles and subsidizing replacement purchases of old and outdated vehicles. It has also moved forward the implementation of stricter vehicle emissions standards to July 1 this year from July 2020.


In addition, Chinese steel market watchers expect Beijing to ease its approach to deleveraging and credit schemes in the remainder of 2019, which could help support consumption.


Beijing is striving to present a stable economy to the world ahead of the 70th anniversary of the founding of the People's Republic of China on October 1, and may continue to pull fiscal levers if trade tensions with the US continue to erode consumer and investor confidence.


However, some steel market watchers said the strong fiscal expenditure growth over January-April was unlikely to continue over the rest of 2019 as revenue growth was likely to keep slowing as a result of tax cuts and falling land sales.


This means infrastructure construction, funded mainly by government spending, will continue to recover going into Q3, but only mildly.


The devaluation of China's currency is a potential threat to property developers, as foreign currency debt typically makes up about 30% of total borrowing for Chinese developers, S&P Global Ratings said in a recent report. The offshore yuan had devalued by 4.2% against the US dollar between mid-April and mid-May.


However, as long as property sales remain strong enough to support revenue and profit margins, the sector has financial and liquidity buffers to withstand some currency pressure, it added.


Source: S&P Platts

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