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Shrugging off SARS, the economies of most countries in the region are surging ahead

January 12, 2004 | A version of this story appeared in Volume 82, Issue 2

Hong kong has more or less gone back to its old self. The taxi drivers are more surly than chatty, most planes in and out of the former British colony are full, investors are having gold rush fever over new stock issues, and the sidewalks are jammed with tourists. For those who don't care to wait for the official statistics, these are promising signs that Hong Kong has bounced back from its lengthy economic malaise.

The tiny Hong Kong economy heavily relies on its regional neighbors for its prosperity. And the Asian giants--Japan, China, and India--are doing very well, thank you. The Asian Development Bank (ADB) estimates that China likely grew 8.5% in 2003, 1.3% more than ADB had predicted a year ago. Japan, Asia's largest economy, grew by an estimated 2.7%, about three times what ADB had expected. And India also beat the forecast by growing by 6%, half a percentage point better than had been expected.

The strength of Asian growth is remarkable given that an economic slowdown, rather than a formidable expansion, would be easier to explain. Foreigners working on investment projects and those purchasing goods from the region mostly avoided Asia this spring, either because they were barred by their companies or because they were personally scared of falling victim to severe acute respiratory syndrome (SARS). Oil and natural gas prices remained high for most of the year, something that would normally harm the energy-deficient region. The Japanese yen surged by 13% versus the dollar, and the Indian rupee, by 5%. Yet despite it all, Asian economies kept on ticking.

China's industrial output rose 18% in November 2003 from November 2002, according to China's bureau of statistics. In the past few years, "China never went into any kind of slump," says David H. Witte, director of the Asian operations of Chemical Market Associates Inc., a consulting firm. And as the world economy emerges from its own slump, growth in China is accelerating. "Beyond the growth of consumption in its own population, it also services the rest of the world in terms of finished goods exports," Witte adds.

China's outstanding economic performance is having a major impact on the Asian chemical industry. The country is mentioned in nearly every financial statement released by chemical companies in the region. Based on numbers for the first 10 months of 2003, China last year increased its imports of chemicals by more than 40%. Most of this increase was due to increased imports of organic chemicals, a category that includes polymers.

As it experiences high profitability in its chemical operations, China Petroleum & Chemical Corp. (Sinopec) is speeding up the renovation of an ethylene cracker at its Qilu Petrochemical unit as well as a coal gasification project at the same site. Sinopec profits surged 69% compared with a year earlier in the fiscal year's first nine months, which ended Dec. 31. Chemicals account for approximately 20% of the oil company's sales and 7% of its operating income.

THE BUOYANT Chinese economy is helping to prop up Japan. A large portion of the electronic materials, components, plastics, machinery, and engineered goods that China needs to fuel its growth is supplied by Japan, Witte says. Based on numbers for the first 10 months of 2003, it appears that Japanese exports of chemicals--excluding photographic materials--grew 25% in 2003 to nearly $40 billion., the highest amount ever. Unlike in previous years when Japanese production of most chemicals was in decline, a major portion of Japanese-made chemicals has experienced growth in 2003.

And as incomes rise, Japanese consumers purchase more Chinese-made goods, thus creating a "virtuous" circle of growth. Evidence of this circle was not clearly visible in the mixed bag of financial statements released by Japanese chemical companies in their first half. JSR, for example, increased its net profit by 173% over the past year's first half, but Sumitomo's net profit declined by 31% on high depreciation charges. However, chemical companies are generally optimistic about their full-year results--as of March 31. Sumitomo is expecting to boost its net profit by 6% over last year; Mitsui, by 13%; and JSR, by 50%.

The Indian economy is being propelled by strong industrial and agricultural growth. ADB reports that industrial growth reached 6% in the first few months of 2003. Agricultural production received additional impetus from a "normal" monsoon--neither too long nor too short. Agriculture is more important to India than industry, so the rise in rural income had a more positive effect on the economy than the increase in industrial output. ADB expects stronger growth this year as India further benefits from the strengthening of the world economy.

With rising incomes, Indian demand for petrochemicals is strong. Reliance reported a 23% increase in net profit for the half-year ended Sept. 30. This happened despite an unscheduled shutdown of its Jamnagar p-xylene facilities. Overall, Reliance says it experienced 16% growth in demand for its petrochemical products, which it was able to supply by having most of its plants producing beyond their nameplate capacities. In an upbeat forecast in October, Chairman and Managing Director Mukesh D. Ambani said, "We are seeing signs of an upturn in the petrochemical cycle and are confident of achieving even better performance in the future."

If Asia has a bellwether producer, it has to be Singapore. The city-state is home to several worldscale refineries, petrochemical complexes, and pharmaceutical facilities that sell most of their output in the rest of Asia. The Singapore Economic Development Board (EDB) reports that manufacturing as a whole grew by over 19% in October 2003 compared with October 2002. Chemicals, which in Singapore also includes oil refineries, grew by a more moderate 4.4% as a result of several maintenance shutdowns.

EDB further reports that business expectations in the six months from October 2003 to March 2004 are neutral and that most petrochemical producers are foreseeing business conditions similar to those they experienced in the previous six months. However, they expect as a group to produce and export more because fewer maintenance shutdowns are scheduled.

Stable business conditions in the region's petrochemical business would not be a bad thing. In the past few months, petrochemical producers have enjoyed strong demand and decent margins. This is particularly true for aromatics producers. Investment in new aromatics production facilities has been insufficient in the past six or seven years, CMAI's Witte says, because profitability has been so low. This inadequate investment is now leading to a relative shortage, especially in Asia. Basic aromatics such as mixed xylenes, toluene, benzene, and p-xylene will be doing particularly well, Witte says. This is partly because several investors are building polyester and purified terephthalic acid plants in China that depend on aromatics for feedstock.

Olefins and polyolefins will comparatively not do as well. "Olefin margins around the world will be improving, but not to the levels we are seeing in the aromatics," Witte says. The star product in the near term, he says, will be ethylene glycol.

The electronics industry is on the rebound, pulling electronic materials producers along with it. The world's largest semiconductor manufacturer, Taiwan Semiconductor Manufacturing, reported a third-quarter 2003 net income of $450 million, nearly five times as much as in the third quarter of 2002, as its capacity utilization rate jumped from 84% to 98%. The company said it expected its shipments to increase in coming months and capacity utilization to stay high.

The current year will be an important one for electronic materials suppliers, according to Seiichi Hasegawa, managing director of JSR's electronic materials business. It will be the first year that 193-nm circuitry is implemented commercially in the manufacturing of semiconductors, he says. There will also be more demand for complex and highly integrated microchips that are the key components of hot consumer products such as multifunctional mobile phones. "The complexity of the chip design and process integration will require more advanced and enabling materials," he says. He adds that 2003 was the year when demand for liquid-crystal displays began to explode, a trend that is ongoing. This is translating into additional sales for suppliers of electronic materials.

Shin-Etsu Chemical reports that sales and operating profits in its silicon wafer businesses have been improving in the half-year ended Sept. 30. For the second half, it expects strong sales of 12-inch silicon wafers, even as it predicts an uncertain environment for its other products. At Sumitomo Chemical, the electronic materials business turned a profit of $32 million in the first half, compared with a loss of about $2 million a year earlier.

CLEARLY, 2004 is set to be a good year for Asia's chemical industry. The main shadows on the horizon arise from general economic and political conditions that the industry does not control.

One risk is the excessive prevalence of optimism. Marc Faber, a Hong Kong-based professional investor who is also the editor and publisher of the newsletter "The Gloom, Boom & Doom Report," wrote, "I am wary because every fund manager I talk to is wildly bullish about Asia." To contrarian investors like Faber, this is a sign that markets are overheating. He predicts a slowdown in the Chinese economy, something that can already be perceived from slower loan growth and the fact that inventory levels are higher than they have been in years.

More worrisome, Faber says, is the increasing assertiveness of pro-independence Taiwanese. China has in past decades refrained from military operations against Taiwan because the island has not attempted to formally break away. Taiwan President Chen Shui-bian, however, has been promising during his reelection campaign to hold an island-wide referendum this spring. China has made it clear that it plans to go to war if the question on the ballot is independence for Taiwan.

ADB is alert to additional threats to Asian economies. The most obvious one, the return of SARS, is not particularly scary, ADB says. This is because governments in the region are far better prepared and the public is better informed than last year. New cases are likely to be quickly isolated without causing undue alarm, as is already unfolding in China. More seriously, the threat of terrorism could harm the Indonesian or Thai economies, which are dependent on tourism and foreign investments.

But ADB is most concerned about global economic uncertainties. A likely increase in long-term interest rates in the U.S. could stall the burgeoning recovery there, as well as in other parts of the world. Moreover, although Asia is often accused of taking jobs away from richer countries, the bank is concerned about a U.S. economic recovery that doesn't involve adding jobs. Such a development would affect U.S. consumer spending and, therefore, have an impact on Asian exports.

In the past few years, Asian economies have chugged along despite large threats to their prosperity. When the bottom did fall out in late 1997, it was mostly a complete surprise. Many expected in 1998 and 1999 that the Japanese economy would collapse as a result of the shaky state of its banks. But the Japanese government took over a few banks, and the economy held together. In late 2002, a few months ahead of the war in Iraq, ADB predicted that a sustained rise in oil prices would slow down global as well as Asian growth. Oil prices did stay high, but Asian economies grew faster than predicted.

The main risks for the coming year are sharply higher interest rates, a slowdown in China, and a war between China and Taiwan. If none of these comes to pass, chances are that, economically speaking, 2004 will be even better than 2003.


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