China’s Factories Losing Pricing Power in Earnings Threat

Chinese factories are losing pricing power in the worst wholesale-cost deflation since 2009, signaling corporate earnings may deteriorate further and putting a damper on global inflation pressures.

Steelmaker China Oriental Group Co. (581) says falling prices are wiping out profits, while Yunnan Copper Industry Co. (000878) cited the declines for a third-quarter loss. The producer-price index (SHCOMP) fell 3.6 percent in September from a year earlier and may stay negative until the second half of 2013 without large stimulus, according to Mizuho Securities Asia Ltd.

With the U.S. reporting the longest stretch in three years that Chinese imports have gone without a price increase, the trend also gives policy makers around the world more room for easing to support faltering global growth. Sluggish earnings growth may prompt the government to reduce corporate taxes to aid earnings and help boost spending after China’s expansion slowed for a seventh quarter.

“Reduced inflation pressure should expand the space for policy makers to take pro-growth actions in their countries,” said Shen Jianguang, chief Asia economist at Mizuho in Hong Kong. Chinese officials are likely to reduce banks’ reserve requirements ahead of a Communist Party congress next month, said Shen, who formerly worked at the International Monetary Fund and European Central Bank.

Largest Drop

Chinese industrial companies’ profits dropped 6.2 percent in August from a year earlier, the largest decline this year and the fifth straight monthly deceleration, a statistics bureau report showed last month. Data for September are due Oct. 27.

Last month’s 3.6 percent drop in wholesale prices from a year earlier was the seventh straight decline and biggest since October 2009. The decline was caused primarily by weak demand and also by overcapacity, Sheng Laiyun, spokesman for the National Bureau of Statistics, said at a press briefing Oct. 18.

Falling earnings have weighed on Chinese stocks this year. The nation’s benchmark gauge, the Shanghai Composite Index, has declined about 3 percent in 2012, heading for the third straight annual drop. It was down 0.5 percent as of 2:12 p.m. local time. The MSCI Asia Pacific Index is up more than 7 percent this year and fell 0.4 percent at 3:11 p.m. in Tokyo.

Elsewhere in the Asia-Pacific region, Sri Lanka left interest rates unchanged for a sixth month. Singapore’s inflation accelerated more than economists estimated in September, supporting the central bank’s decision to refrain from easing monetary policy this month.

In Taiwan, industrial production probably rose 6.5 percent in September from a year earlier, which would be the biggest gain since February, a Bloomberg News survey showed.

French Confidence

In Europe, France will report October measures of industrial confidence and the production outlook while the U.K. will report mortgage approvals for September.

The Bank of Canada will probably hold its benchmark interest rate at 1 percent, extending the longest pause since the 1950s.

Vice Premier Li Keqiang, who may succeed Premier Wen Jiabao in March, said the country should introduce more structural tax cuts and expand to the whole country a trial program of levying a value-added tax instead of a tax on revenue, according to a Xinhua News Agency report on Oct. 21.

China’s economy expanded 7.4 percent in the third quarter from a year earlier, compared with 7.6 percent in the April-June period. The International Monetary Fund this month cut its forecast for global growth this year to 3.3 percent from a previous estimate of 3.5 percent.

Dariusz Kowalczyk, senior economist and strategist at Credit Agricole CIB in Hong Kong, said China’s government should offer more tax support and increase subsidies in some industries to help cope with falling prices.

Import Prices

Data from the U.S. Labor Department showed prices of imports from China rose almost every month from September 2010 to February 2012 before declining or remaining unchanged since then.

JPMorgan Chase & Co. projects global consumer prices will rise 2.8 percent in the second quarter of 2013, the same pace as in the second and fourth quarters of 2012, according to an Oct. 19 research report which didn’t include forecasts for other periods.

U.S. Federal Reserve policy makers last month decided to start a third round of large-scale bond buying to aid growth, while the Bank of Japan expanded its asset-purchase program by 10 trillion yen ($126 billion).

To be sure, the worst of the deflation may be over, according to economists at Citigroup Inc., who forecast year- over-year producer-price declines to ease starting this month on improved demand and new projects.

Monthly Change

Wholesale prices declined 0.1 percent in September from the previous month, compared with a 0.5 percent drop in August, government data showed. Official data showed signs of an economic pickup in September, with factory output and retail sales accelerating.

The economy is in the early stages of a recovery and “corporate profits may rebound in the next two quarters,” said Zhang Zhiwei, chief China economist at Nomura Holdings Inc. in Hong Kong.

A rebound can’t come soon enough for companies including Angang Steel Co. (347), China’s largest Hong Kong-traded producer of the alloy. Angang on Oct. 12 projected a loss of 3.17 billion yuan ($507 million) for the first nine months of this year on a weak market and low prices.

Some companies based outside China are also suffering. LG Chem Ltd. (051910), South Korea’s biggest chemical producer, said Oct. 19 that it posted a 10 percent drop in third-quarter profit as demand waned in China, its biggest market. Rio Tinto Group, the world’s second-biggest mining company by market value, said Oct. 10 it will cut jobs and delay decisions on building projects because of reduced growth in China.

Damping Investment

Producer-price deflation “will hurt profits and this has already damped corporate investment,” said Tim Condon, chief Asia economist at ING Financial Markets in Singapore, citing fixed-asset investment growth of 20.5 percent for the first nine months of 2012, compared with 24.9 percent expansion in the same period a year earlier.

The drag should cease once PPI rises on a month-to-month basis, said Condon, who previously worked at the World Bank.

“The crimp on profitability is certain to damp down investment appetite at the corporate level, dragging on the government’s ability to restore stability to the economy,” said Alistair Thornton, an economist in Beijing at IHS Global Insight.

--Zheng Lifei. With assistance from Karl Lester M. Yap in Manila. Editors: Scott Lanman, Rina Chandran

To contact Bloomberg News staff for this story: Zheng Lifei in Beijing at lzheng32@bloomberg.net

To contact the editor responsible for this story: Paul Panckhurst at ppanckhurst@bloomberg.net

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