China: Material improvement in industrial profits - ING

It is not just a base effect from the clean-up of the material sectors helping the growth rate but meeting demand for high tech goods means China is climbing up the value chain, according to Iris Pang, Economist at ING.

Key Quotes

“Industrial profits should keep growing at double digit growth rate (INGF: 20.0%; prior: 21.2% YTD YoY in Aug), though sliding slightly as base effects fade. We expect mining will continue to rank top in terms of growth rates. But in terms of profit levels, the automobile industry will continue to be the number 1 profit-maker.”

“This suggests that supply reform to reduce overcapacity have yielded positive results.”

“Furthermore, the data implies that new sectors are doing well, too. Automobiles, computer-related, electrical products, and pharmaceuticals have scored well in terms of industrial profits in CNY terms. We expect this trend to continue not only in August’s data but for the rest of the year, and into next year. In other words, upgrading China’s manufacturing is sustainable.”

“But such gains are not without costs. The most obvious is the increase in account receivables (at 3.5% of total industrial profits YTD in July 2017)). This will continue to rise quickly (INGf: 9.2%YoY YTD; prior: 9.4) as the clean-up of excess capacity has not yet been completed. Smaller companies will face even higher account receivables from their buyers, especially from larger buyers who have more bargaining power. As supply-side reform continues, which we believe will occur, will likely be confirmed in the 19th Party Congress, account receivables will continue to increase. Only nearer the completion of reforms will this problem fade.”

“Can China’s economy balance its risks and opportunities as manufacturing climbs up the value chain? It is likely that China will gain more from the opportunities than it stands to lose from rising account receivables. Demand for high tech goods from the rest of the world is pushing manufacturing to meet the demand. Therefore, China’s climbing up the value chain is not just a fancy face-lift project. As long as growth of industrial profit keeps rising faster than account receivables, the impact of losses should be modest for the economy as a whole, but smaller companies will certainly suffer more.”