Friday, 24 January 2014

What falling steel production growth says about Chinese GDP

Chinese power demand is a closely watched lead indicator due to its correlation with Chinese GDP growth. Less known is the high correlation between steel and power production in China. This relationship is not only statistical but also causative. Steel production directly uses around 15% of power in China and all industrial metals (including aluminium, copper and zinc) use around 30%.

Since some steel production data is reported before power and GDP data, this can provide some insight, and right now falling steel production growth is causing us to worry about first quarter GDP growth. Steel production growth fell from 7.5% for 2013 to 6.5% year-on-year in December, according to the National Bureau of Statistics (interestingly power demand growth also weakened from 7.5% in 2013 to 5.9% year-on-year in December). CISA (the China Iron and Steel Association) reported that production growth for the first 10 days of January fell further, to 2.7% year-on-year.

What does this mean for GDP growth? The Chinese power intensity of growth (the ratio of power demand growth to reported GDP growth) has fallen from 1.3x in the decade to 2008 to around 1x since. Steel intensity of growth has also fallen from around 1.5x pre 2009 to an average of 0.6 since (see the chart below).

A 2.7% steel production growth rate could imply Chinese GDP growth of around 4.5%. We view this as a highly unlikely scenario - steel production can be volatile and change significantly from week to week. However, the steel production trend in December and early January does make the first quarter consensus forecast, which is currently 7.60%, look on the high side.

Nik Stanojevic CFA
Divisional Director

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