Inventory pressure is up, not down, so investment key

Workers hoist steel bars at a logistics park in Huzhou, Zhejiang province. (YAO HAIXIANG / FOR CHINA DAILY)

The National Bureau of Statistics releases inventory indexes at the end of every month. The most recent data showed that year-on-year growth rates of both general inventories and finished goods inventories of industrial enterprises are back on a track of decline since May, while the yearly growth pace of inventories started decreasing even earlier — since November last year.

Does that mean inventory pressure on enterprises is declining?

Both indexes are nominal, and their changes are influenced by prices of manufactured goods. That is to say, it is not accurate to rely merely on such data to assess the real state of enterprise inventory pressure.

What really matters is not changes in index growth paces, or changes in enterprise inventory levels, but rather gaps between actual inventory levels and desirable inventory levels of enterprises.

We therefore designed a new indicator — "generalized inventory-to-sales ratio" — to assess inventory situations of enterprises. The generalized inventory-to-sales ratio equals inventory divided by operating income during any given month.

We found out that in the past 10 years, industrial enterprise inventory situations as indicated by the generalized inventory-to-sales ratio can accurately reflect macroeconomic conditions.

Since the second quarter, the generalized inventory-to-sales ratio of industrial enterprises has been on the rise, which means the current inventory pressure on industrial enterprises is not declining, but rather, increasing.

In other words, the decline in the year-on-year growth rate of finished goods inventory does not mean that industrial enterprises are really destocking. Such a change only appears in yearly readings and does not mean inventory pressure faced by enterprises is easing. Although industrial enterprises seem to be "actively" reducing inventory, as a matter of fact they face increasing inventory pressure and have to take appropriate measures.

Although inventory pressure on industrial enterprises is on the rise, that does not mean the pressure is climbing at the same pace in all industry sectors.

Since the second quarter, the generalized inventory-to-sales ratios for raw materials, intermediate goods, capital goods and consumer goods all increased. Yet the capital goods sector has suffered from greater inventory pressure compared with the others, as generalized inventory-to-sales ratios showed.

To be specific, the new indicator showed that the raw materials sector, despite higher inventory pressure, is still below average pre-COVID levels. That for consumer goods is slightly higher than average pre-pandemic levels, and yet is still below the peak level in the early stage of the pandemic, which occurred in the third quarter of 2020. As for capital goods, the ratio is currently at its highest level since 2014.

Such differences have also occurred in the changes of profit rates and exports. We divide combined profits by revenue to assess profit rates of different sectors, and according to our calculations, profit rates of all the above-mentioned sectors have decreased since the second quarter of the year.

Yet, profit rate for the raw materials and intermediate goods sector decreased slightly to remain above pre-pandemic levels, while consumer and capital goods have seen profit rates already fall below pre-pandemic levels.

Such a phenomenon has also occurred in exports. The downturn in the export growth pace since the second quarter is mainly attributable to the decline in capital goods exports.

Our research showed that since the second quarter, the contribution of capital goods exports to overall exports by volume has become much less than that of raw materials and intermediate goods as well as consumer goods sectors. Capital goods contributions to overall exports since the second quarter have also become much lower than the average level of last year.

In conclusion, inventory pressure on industrial enterprises is increasing, and inventory pressure in the capital goods sector is obviously higher than that of raw materials and intermediate goods as well as the consumer goods sector.

In the past 10 years or so, whenever macroeconomic growth began to lose steam, increased inventory pressure often first struck enterprises in the raw materials and intermediate goods sector, such as steel and nonferrous metal enterprises.

However, thanks to supply-side reforms, overcapacity issues in the raw materials and intermediate goods sector have been substantially alleviated. In recent years, constrained supplies from these sectors have instead become the focus of market attention.

Even though China's real estate industry has undergone a year of intense adjustment, inventories of related industries have not piled up significantly. As a matter of fact, the supply elasticity of these industries has been significantly improved to flexibly adjust to dynamic demand situations and therefore avoid sharp increases in inventory.

On the contrary, the capital goods sector, although facing greater inventory pressure, still maintains a significantly higher growth rate of fixed asset investment than the raw materials and intermediate goods and consumer goods sectors.

Since 2021, the growth rate of fixed asset investment in the capital goods sector has always been higher than the other two sectors. On the one hand, this explains why the sector faces lower profit margins than consumer goods — more current profits are converted into capital expenditures. On the other hand, it also shows that the entire capital goods sector, after two years of continuous investment growth, has experienced substantial expansion of effective supply capacity.

As external demand continues to decline, existing production capacity must find new ways to export products, otherwise inventory pressure will gradually intensify.

Moreover, structural differences among industrial sectors have manifested themselves in the financial market. Since the beginning of the year, the capital goods index has performed significantly worse than that of raw materials and intermediate goods as well as the consumer goods sector.

As of the end of September, the capital goods sector index had retreated by nearly 20 percent compared to the end-August level, while the indexes of raw materials and consumer goods sectors experienced a contraction of less than 10 percent.

The capital goods sector is set to expand capacity, conforming to the trend of China's industrial transformation and upgrade. Next, as continuous declines in external demand are highly likely, we will face challenges in finding new demand for the capital goods sector to maintain effective production capacity.

That is to say, we need to boost demand for investment. In particular, we need to promote investment in the infrastructure and real estate sectors. That is because investment in infrastructure and real estate can better boost demand in other industries, especially in the capital goods sector, compared with investment in manufacturing.

Therefore, China's macroeconomic policies should continue to focus on expanding infrastructure investment and stabilizing real estate investment.

Although a flurry of policies has been released recently to stabilize the development of real estate, we believe China needs to step up macroeconomic policies to stabilize the short-term economy as well as enhance the structure of the economy over the long run.

The writer is deputy director of the research department of the China Finance 40 Forum, a think tank.

The views don't necessarily reflect those of China Daily.