JOHANNESBURG: Leaders of the BRICS emerging economies, which account for about a quarter of the world’s wealth, meet in Johannesburg this week looking to widen the bloc’s influence and push for a shift in global geopolitics. South Africa’s Cyril Ramaphosa is expected to host China’s President Xi Jinping, India’s PrimeContinue Reading
The price of hedging China risk on world markets hasn’t fluttered during the past couple of weeks, which means that investors with real money on the line and speculators looking for a score aren’t worried about China’s property market.
Credit default swaps are a form of bond insurance that makes creditors whole after a default. They are quoted in basis points (100ths of a percent) above the cost of interbank funding. The cost of default protection on China traded Aug. 18 at 80 basis points, on the lower side of its historic range.
Even in an extreme case, I showed in a companion article, China’s central government could cover the interest payments on defaulted local government debt with a bit over 1% of tax revenues. The shakeout in the property market and the financial vehicles that lend to it, including Local Government Financing Vehicles, isn’t a financial crisis as such; rather, Beijing is asserting central control over local governments that have coasted for years on rising land prices.
The broad Chinese corporate bond market has ignored the property market fallout.
There’s a world of difference between the performance of property bonds, which make up most of Bloomberg’s China High Yield US Dollar Index, and the performance of investment-grade Chinese corporate bonds. The chart above shows that the high-yield dollar bond index has lost more than three-quarters of its value since the middle of 2021.
But the overall China bond index has registered positive returns throughout, and Bloomberg’s index of lower investment grade Chinese corporate bonds (rated Baa by Moody’s) has gained as well. The US corporate bond market has fallen in value because the Federal Reserve pushed up US interest rates. Bond prices move inversely to yields.
China’s RMB (ticker CNH) is lower against the US dollar, but that’s due to higher US dollar interest rates, not RMB weakness. The Chinese currency has traded in lockstep with the Japanese yen for the past year.
In regression analysis, US “real” yields (the yield on 5-Year Treasury Inflation Protected Securities) and Chinese government bond yields explain 80% of the movement in the Chinese currency, as shown in the chart above.
The cost of hedging the Chinese RMB against the US dollar, measured in points of option-implied volatility, is in the middle of the range that has prevailed since 2015.
The volatility of short-term interest rates in China meanwhile is close to the bottom of its long-term range. During real periods of stress, such as the Great Financial Crisis or the Covid recession of 2020, rate volatility jumped in China. It hasn’t moved in the past month.
Chinese financial stocks are still up over the past year, which we would not expect to see if the financial system were at risk.
The simple fact is that countries with enormous trade surpluses and very high savings rates don’t have financial crises. The Chinese government has the resources to cover the debt service of dodgy local government debt if it so chooses, and the banking system has vast resources to issue new loans. Whether Beijing will do so is a political, not a financial choice.
An application in the United States seeking protection from creditors while Evergrande Group restructures its heavy debt has burdened Chinese stocks as it fueled investors’s concerns about China’s property crisis.
Evergrande asked protection from creditors under Chapter 15 of the US bankruptcy code, which is invoked when insolvency cases involve multiple countries. The company said it needs the protection while it makes efforts to restructure its debt during upcoming negotiations in Hong Kong and the Cayman Islands. Chapter 15 is used less commonly than chapters 7 and 11.
Hui Ka-yan, chairman of Evergrande, explained in a stock exchange filing on Friday that the company’s bankruptcy protection application is a normal procedure for offshore restructuring and does not involve an actual bankruptcy petition. He said the company is pushing forward its offshore debt restructuring as planned.
The Shenzhen-based property developer, which defaulted in mid-2021 and started restructuring its debt early last year, filed for Chapter 15 protection in New York on Thursday. The company proposed scheduling a Chapter 15 recognition hearing for September 20.
The Hang Seng Index, Hong Kong’s stock market benchmark, fell 375 points or 2.1% to close at 17,950 on Friday, the lowest level in 10 months and below the psychological mark of 18,000. The Shanghai Composite Index fell 31 points or 1% to 3,131 on Friday.
In fact, the Hang Seng Index has dropped by 10.6% so far this month while the Shanghai Composite Index has plunged 4.8%. Reuters reported on Tuesday that global hedge funds were dumping Chinese stocks in the first two weeks of this month due to fears about China’s property crisis.
Simon Lee Siu-po, a senior lecturer at the Chinese University of Hong Kong Business School, told the Hong Kong media that with bankruptcy protection in the US, Evergrande can prevent American banks from filing lawsuits against it and buy more time to restructure its offshore debts and continue its property projects.
Lee said it’s a political decision that Evergrande has not gone bankrupt in China as its bankruptcy would lead to a suspension of construction works and also hit its lenders.
He said it’s possible that other indebted Chinese property developers, such as Country Garden, will also file for bankruptcy protection in the US. However, he said more applications of this sort would hurt foreign investors’ confidence in the Chinese property sector.
Liu Zefeng, a Beijing-based solicitor at Jing Zhe Law Firm, told the mainland media that a company can apply for bankruptcy protection if its liabilities are more than its assets.
“If a company can successfully restructure its debts, it can ‘wake from the dead and return to life,’” Liu said. “The chance for Evergrande to have a successful debt restructuring is high as creditors can restore much more money from a haircut than a liquidation.”
He added that it’s unlikely that Evergrande’s debt restructuring or liquidation would affect Chinese homebuyers as they are well protected by China’s laws.
However, Evergrande is facing rising challenges with its huge losses and liabilities and its subsidiaries’ weakening share prices.
The company said on July 17 that it lost a combined 803 billion yuan (US$110 billion) in 2021 and 2022. At the end of last year, it had net current liabilities of 687.7 billion yuan and total liabilities of 2.44 trillion yuan.
Trading of Evergrande’s shares has been suspended since March 2022 due to its offshore debt restructuring. According to the Hong Kong stock exchange’s rules, if the trading cannot be resumed by September 20, the shares must be delisted.
On March 22 this year, Evergrande said it had engaged in constructive dialogue with the stakeholders of its and its subsidiary’s US dollar-denominated senior secured notes worth a total of US$19.12 billion.
The company proposed to its creditors that it either issues them new notes that will mature in 10 to 12 years, or bonds that are exchangeable into 21.57% of Evergrande Property Services (EVPS)’s shares and 28.54% of Evergrande New Energy Vehicle (NEV)’s shares.
The convertible bonds are only worth HK$9.38 billion (US$1.2 billion) at the current values of the EVPS and NEV. They are equivalent to 6.3% of the unpaid senior secured notes.
Shares of EVPS fell 9.1% to close at 60 HK cents while shares of NEV dropped 16% to HK$1.26 on Friday. Shares of EVPS and NEV are 60% and 73.9% off, respectively, from their levels in March.
On August 14, Evergrande said NWTN, a Dubai-based and Nasdaq-listed company, agreed to purchase a 27.5% stake in NEV for US$500 million, or 63 HK cents per share, which represents a 59% discount to the average closing price of HK$1.55 for the last five trading days.
The Securities Times said NWTN, formerly known as ICONIQ, was founded by a 41-year-old Zhejiang man called Wu Nan in 2014 and had cash and cash equivalents of US$212 million and total liabilities of US$71.97 million at the end of 2022. It said NWTN had zero revenue in the past three years.
Evergrande will then issue convertible bonds for NEV’s shares to its creditors. NWTN will become the largest single shareholder of NEV.
Evergrande said in March that if it is forced to liquidate its assets, offshore holders of its senior secured notes can only recover about 5.92 to 9.34% of their money while other offshore unsecured creditors can get back 2.05 to 3.53%.
Since 2022, the company has extended payment dates for nine onshore corporate bonds, comprising 53.5 billion yuan in principal and 3.7 billion yuan in interest. Besides, its overdue onshore debts amounted to 749.2 billion yuan, including 208.4 billion yuan of interest-bearing debt, 326.3 billion yuan of commercial papers and 157.3 billion yuan of contingent liabilities, at the end of last year.
The company said it will have to raise about 250 to 300 billion yuan in the next three years to complete its core task of “ensuring delivery of properties.”
Read: China’s property crisis hits state-owned developers
Follow Jeff Pao on Twitter at @jeffpao3
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China’s Zhongzhi Enterprise Group headline-making revelations have investors uttering global markets’ least favorite word: contagion.
A liquidity crisis at the troubled shadow bank comes just days after property development giant Country Garden missed coupon payments. Concerns surrounding Country Garden’s finances echo the China Evergrande Group default debacle of 2021.
Yet trouble in China’s US$3 trillion shadow banking sector raises the stakes considerably. The extreme opacity that pervades the industry means that neither investors nor credit rating companies know the true magnitude of leverage in the financial system.
Zhongzhi, with businesses ranging from mining to wealth management and high exposure to real estate, is a microcosm of the problem.
Its stumble has triggered broader fears of additional dominoes among Chinese conglomerates to fall. PTSD from earlier collapses of Anbang Insurance Group and HNA Group is just below the surface.
Since the end of July, Zhongrong International Trust Co, a leading company controlled by Zhongzhi, has missed dozens of payments on investment products.
It’s the latest sign of how China’s property debt woes are rippling through the economy and imperiling global markets.
“The worry is that a ‘Lehman moment’ beckons, threatening the solvency of China’s financial system,” says economist Xiaoxi Zhang at Gavekal Dragonomics.
Economist Ting Lu at Nomura Holdings adds that “markets still underestimate the aftermath of the significant collapse in China’s property sector.”
Concerns about Zhongzhi, which has more than 1 trillion yuan of assets under management, Zhang says, is a reminder that “debt strains from property developers and local government financing vehicles are spreading across China’s economy.”
The good news, Zhang adds, is that regulatory vigilance means a rerun of the 2008 US crisis is unlikely. The bad news is that debt strains are popping up in too many sectors for comfort.
In the case of Zhongzhi, its affiliated companies offer trust products and private “directed financing” wealth-management products to high-net-worth individuals.
These target aggressive returns — typically above 6% per year — in part by investing heavily in so-called “non-standard assets,” a residual category that spans products from trust loans to accounts receivables.
The end borrowers, Zhang explains, are often firms that can’t access traditional bank loans so they turn to these more expensive shadow-financing channels.
They include many property developers and off-balance sheet local government financing vehicles, which face serious debt problems this year.
“The elevated risk of this type of lending is reflected in returns on ‘collective’ trust products,” Zhang says, “which raise funds from more than one investor — the majority of trust products. These returns have remained elevated in recent years, even as bank lending rates and corporate bond yields have fallen.”
Goldman Sachs analyst Shuo Yang notes that “given the recent net asset value markdowns and redemptions, we expect growth in trust products to slow, which could result in tighter property financing conditions, and affect banks’ earnings and balance sheets.”
Those financing conditions are partly contingent upon the direction of central bank policies from Washington to Tokyo.
Economists at ING Bank wrote in a note to clients that “we think the Fed will indeed leave interest rates unchanged in September, but we don’t think it will carry through with that final forecast hike.” They worry that further rate hikes could heighten the chances of recession.
Yang’s Goldman colleague, chief economist Jan Hatzius, says the US Federal Reserve’s first rate cut after tightening 11 times in 17 months, will likely be in the second quarter of 2024.
By then, “we expect core personal consumption expenditure inflation to have fallen below 3% on a year-on-year basis and below 2.5% on a monthly annualized basis, and wage growth to have fallen below 4% year-on-year.”
Hatzius adds that “those thresholds for cutting align roughly with the annual forecasts in the [Fed’s] summary of economic projections and the conditions at the outset of the last cutting cycle motivated by an intent to normalize from a restrictive policy stance as inflation came down in 1995.”
In 2022, Hatzius adds, “We initially took the view that the Fed was unlikely to cut until a growth scare emerged, but we softened our stance earlier this year and have since assumed that a convincing decline in inflation would probably be enough to prompt cuts.”
This could relieve pressure on the People’s Bank of China to manage a widening gap between US and Chinese debt yields. In the meantime, though, analysts at Citigroup expect more trust defaults as headwinds bear down on China’s property sector. But in a recent note to clients, they stopped short at predicting of Lehman Brothers-like reckoning.
“As the problems in the property development sector are not new and have already been unfolding for several years, we think investors would have already psychologically prepared for the potential of defaults,” Citi writes.
Yet the opacity that surrounds the property sector is intensifying worries that Country Garden won’t be the last company to delay payment on private onshore bonds.
“Unlike banks, which have holding power and are able to roll over credit to wait for an eventual resolution, alternative financing channels such as trusts may default once trust investors are unwilling to roll over the products,” says analyst Katherine Lei at JPMorgan.
“The default events may lead to a chain reaction on developer financing, adding stress to privately-owned enterprise developers and their creditors,” Lei said.
The geopolitical scene is adding fresh headwinds for President Xi Jinping’s economy. Last week, US President Joe Biden banned US investors from investing in sections of China’s chips, quantum computing and artificial intelligence industries.
The step could upend efforts to lift Sino-US ties from their historic lows, adding to the reasons why investors are worried about China’s trajectory.
This latest step is “spectacularly bad timing for China,” says economist Eswar Prasad at Cornell University. It comes as confidence is “falling, growth is stalling” and China “seems to be sliding into a downward spiral” amid deflation, low growth and lack of confidence all feeding on each other, Prasad says.
Analyst Gabriel Wildau at political risk advisory Teneo notes that “the investment restrictions largely mirror export controls already in place, including those that ban exports to China of machinery and software used to produce advanced semiconductors.”
Wildau adds that “unprecedentedly tough restrictions that the US Commerce Department issued in October – soon to be expanded – already rendered new US investment in advanced Chinese semiconductor production effectively impossible, since any such factory would need imported equipment covered by those restrictions.”
All this, warns Jens Eskelund, president of the European Union Chamber of Commerce in China, amounts to a “perfect storm” damaging foreign investors’ confidence in Asia’s biggest economy.
“From an FDI perspective, China is experiencing a perfect storm in which there are many factors now conspiring,” Eskelund told the South China Morning Post, referring to supply chain chaos, manufacturing disruptions, geopolitical tensions and slowing economic growth that “affect investor sentiment.”
In the second quarter of 2023, multinational companies turned “less optimistic” on China in terms of macro trends, consumption, labor and cost metrics, according to Morgan Stanley’s mainland sentiment Index.
Morgan Stanley analyst Laura Wang notes that this marks the first time since late 2021 when all four areas showed deterioration.
What’s needed, analysts say, is for Xi’s Communist Party to make good on its 2013 pledge to give market forces a “decisive” role in Beijing’s decision-making. This means, in part, taking steps to put the proverbial horse before the cart.
Over the last decade, Xi’s party tended to over-promise and under-deliver reform-wise.
During the Xi era, China has opened equity markets ever wider to overseas investors. Beijing has done the same with government bonds, which are being added to a who’s-who of global indexes.
Trouble is, access to exchanges in Shanghai and Shenzhen often outpace the domestic reforms needed to ready China Inc for the global prime time.
China, as is often said, is working from its own playbook, one that even detractors grudgingly admit has a way of beating the odds. Myriad times since 1997, analysts, investors and shortsellers predicted a credit-and-debt-fueled crash that has yet to arrive.
Even so, there are certain laws of gravity that still apply to economies transitioning from state-driven and export-led growth to services, innovation and domestic consumption.
One of those laws states that developing economies should build credible and trusted markets before trillions of dollars of outside capital arrive.
This means regulators must methodically increase transparency, prod companies to raise their governance games, devise reliable surveillance mechanisms like credit rating players and strengthen the financial architecture before the world’s investors show up.
On Xi’s watch, China has become less transparent and the media less free. And this is the problem facing Xiconomics: too often China has believed it can build a world-class financial system after, not before, waves of foreign capital arrive.
Follow William Pesek on X, formerly known as Twitter, at @WilliamPesek
Since announcing his bid for the presidency on Jul 19, Mr Ng has reiterated his lack of political affiliations and his experience in managing the country’s reserves through his 45 years in public service.
Mr Ng started his career as an investment analyst in the Ministry of Finance in 1970, before moving to the Monetary Authority of Singapore when it was formed in 1971.
In 1986, he joined GIC and headed the equities and bond department. He held other posts, including managing director of public markets, before being appointed as group chief investment officer in 2007 – a position he held until his retirement in 2013.
The Elections Department, in its statement issued on Friday morning, said the Presidential Elections Committee “is satisfied that Mr Ng is a man of integrity, good character and reputation” based on information available.
The committee noted that Mr Ng was GIC’s group chief investment officer for more than three years.
It was also “satisfied” that given the nature of Mr Ng’s position and performance in GIC, Mr Ng has the experience and ability comparable to a person who was chief executive or held the most senior executive post at a Fifth Schedule entity. Such entities include key statutory boards and government-owned companies such as the Central Provident Fund Board, Temasek and GIC.
The committee added that it was satisfied that Mr Ng has the experience and ability to “effectively carry out the functions and duties of the office of President”.
The next step for those who have qualified is to be nominated as candidates. To do so, they must deliver their nomination papers, along with the certificate of eligibility, community certificate and political donation certificate, on Nomination Day on Aug 22.
Nomination proceedings will take place at the People’s Association auditorium at King George’s Avenue between 11am and 12pm.
If more than one candidate is nominated, Singaporeans will go to the polls on Sep 1, which will be declared a public holiday.
The Japanese stock market has experienced an impressive upswing. Since January 2023, the Nikkei 225 index has risen by around 30% – by far outperforming US and European stocks.
The boom is driven by foreign investors, with Berkshire Hathaway CEO Warren Buffet’s Japan visit seen as a “stamp of approval” for investing in Japan.
The boom is surprising because since early 2023 the corporate sector has had no positive news concerning innovations that would boost the international competitiveness of Japanese products.
As the Bank of Japan (BoJ) has hardly lifted interest rates, financing conditions have remained benign, allowing corporations to postpone restructuring.
Prime Minister Fumio Kishida’s new capitalism has not come with comprehensive structural reforms. The Japanese education system continues to fail to produce innovative human capital and the fast-aging society is becoming an increasing constraint on labor supply.
From this perspective, Japan’s growth perspectives remain gloomy. The boom seems more financial than real, supported by historically low real interest rates in Japan.
Foreigners drove the June 2023 Japanese stock market surge. In the United States and the euro area, the sharp inflation increase since mid-2021 has prompted central banks to lift interest rates high. This has clouded growth perspectives.
As financing costs for corporations have substantially increased and the value of bonds in the balance sheets of banks has declined, financial instability has emerged. With strong wage claims perpetuating inflation, a recession in the United States and Europe may be inevitable to tame inflation.
This seems to have tempted foreign investors to reshuffle funds to Japan, where the pressure on the BoJ to increase interest rates is lower and inflation has been less pronounced, standing at 3.3% in June 2023.
Central Bank Governor Kazuo Ueda remains committed to the yield curve targeting. The average credit interest rate was at 0.7% in June 2023 and the 10-year government yield has remained below 0.5%.
With US and European interest rates rising high relative to Japan, the Japanese yen has depreciated by 36.3% against the dollar since January 2021. This has made Japanese stocks cheap in terms of US dollars.
Despite the slight easing of the yield curve control in July 2023, in the medium-term the scope to increase interest rates for the BoJ remains limited. With government debt amounting to 1.44 quadrillion yen (US$9.6 trillion), raising interest rates would fiscally paralyze the Japanese government.
The BoJ’s large asset purchases have created large deposits for the commercial banks at the BoJ (549 trillion yen as of March 2023). Lifting the interest rates on commercial banks’ deposits by only one percentage point would generate painful interest rate expenses for BoJ of about 5.5 trillion yen.
This implies that Japanese corporations can continue to expect public support via benign financing conditions. With the BoJ continuing to buy government bonds — the equivalent of roughly 70 trillion yen in the first half of 2023 — the Japanese government can also remain supportive of aggregate business activity. There is also a larger scope for subsidies, which were announced for semiconductor and battery production.
Domestically, the yen’s depreciation boosted the revenues of large export-oriented Japanese enterprises. At the same time, depreciation made the acquisition of foreign assets more expensive and repurchases of Japanese stocks more attractive.
In 2022, stock repurchases by Japanese corporations reached a historical peak of 9.2 trillion yen. For 2023, SMBC Nikko Securities has already recorded a volume of 4.6 trillion yen as of mid-May.
While the Nikkei 225 is slowly reapproaching its peak before the bubble economy bursts, the new stock market miracle seems driven by state intervention — as previously in the case of Abenomics.
On top of direct and indirect subsidies, the BoJ has in the past bought large amounts of exchange-traded funds (ETFs). As of June 2023, it held about 57 trillion yen (37 trillion yen in book value) in ETFs. This equated to 81% of all Japanese ETFs.
Whereas the Japanese government and the BoJ keep zombifying Japanese corporations, interest rate increases in the United States and Europe will exert pressure on US and European corporations to increase efficiency and push forward innovation. This suggests that the long-term fundamental growth prospects of stock markets are in favor of the United States.
Japan and its corporations will only be able to recuperate their past strength if the BoJ follows the interest rate policy of the US Federal Reserve. Doing so will prompt the corporations to increase efficiency and urge the government to implement decisive structural reforms.
Taiki Murai is Research Assistant at the Institute for Economic Policy, Leipzig University.
Gunther Schnabl is Professor of Economic Policy and International Economics at Leipzig University.
Will China’s spreading property crisis spread to banks and financial institutions?
Falling home prices have in recent months disrupted Chinese property developers’ plans to sell their units, repay bank loans and purchase lands. Real estate firms’ huge losses and declining stock prices have alarmed investors far and wide.
Zhongzhi Enterprise Group, one of the largest private wealth managers in China, which invested heavily in the property sector, hired KPMG in late July to review its balance sheet amid a worsening cash crunch, Bloomberg reported on Thursday, citing people familiar with the situation.
They were quoted as saying debt restructuring process will be lengthy while Zhongzhi has already suspended payments on nearly all its products.
At the same time, global hedge funds have dumped Chinese stocks, mainly property ones, in the first two weeks of this month as they were bearish about the outlook of China’s property markets, Reuters reported.
Some economists called on the government to launch more measures to boost property markets to prevent the spread of property market woes to the financial system.
In the first four months of this year, after China ended its zero-Covid policy, property prices rose.
Since May, however, home prices have started to fall as many homebuyers refused to enter the markets, particularly as local debt problems in Yunnan, Guizhou and Guangxi provinces grew.
Property developers also offered big discounts to homebuyers as they faced rising pressure to repay their debts.
Of the 70 largest Chinese cities, 44 recorded year-on-year declines in new home prices in July, according to the National Bureau of Statistics (NBS). In June, new home prices fell in 42 out of the 70 cities.
Last month, new home prices still grew 1% year-on-year in first-tier cities and 0.2% in second-tier cities but they fell 0.3% in third-tier cities. Existing home prices decreased 0.8%, 0.5% and 0.4% year-on-year, in first-, second- and third-tier cities, respectively.
Although official data did not show an obvious market slump, media reports said existing home prices in some prime sites in top-tier cities have actually declined by 15% from two years ago while prices in tier-two and tier-three cities have dropped by 25-50%.
“To reflect the real market conditions, existing home prices are more effective than new home prices,” said Xu Xiaole, chief market analyst of Shell Research Institute. “Existing home prices fell month-on-month in all three tiers of Chinese cities in July while the decline in the first- and second-tier cities accelerated.”
Zhang Bo, president of 58 Anjuke Research Institute, said some governments in second-tier cities have lowered down payment requirements for second-home buyers but the policy’s effect was insignificant in some cities. Zhang said a lot more supportive measures should be launched in third-tier cities as those unveiled to date have failed to have an impact.
Over the past two months, several incidents have shown that China’s property crisis is spilling over to the banking and investment sectors.
On July 4, Bloomberg reported that state banks had in recent months been offering local government financing vehicles (LGFVs) loans with a maturity period of 25 years, instead of the normal 10 years. The move will hurt large Chinese banks’ margins over the long run.
Since then, the Industrial and Commercial Bank of China (ICBC) and the Agricultural Bank of China’s shares have fallen by 18.4% and 17.4% respectively. The Bank of China’s stocks have lost 16.1% while the China Construction Bank has declined 19.4% over the same period.
On August 6, Country Garden, once the largest Chinese property developer by contracted sales, failed to pay interest on two bonds worth a total of US$22.5 million. On August 13, Sino-Ocean Group, a state-owned property developer, failed to pay interest of $20.9 million on its $700 million notes.
Also in August, Zhongrong International Trust, a 36-year-old wealth management firm in China, could not give money back to its clients. Its second-largest shareholder Zhongzhi is now under debt restructuring.
Some economists and analysts said the only way to avoid financial contagion is to boost property prices and improve homebuyer confidence.
Zhou Shaojie, a professor in the School of Public Policy and Management at Tsinghua University, and Zhang Yibing, an analyst at CSCI Pengyuan, co-wrote an article with the title “Stabilizing property markets also means stabilizing fiscal income and financial sectors,” which was published on August 16.
“The real estate markets remain the biggest issue that slows economic growth and involves relatively high risks,” Zhou writes. “Many local governments have eased their property curbs but the strength is still not enough, especially those in the top-tier cities.”
“The current society has seen many new risks, such as defaults of LGFV loans and falling fiscal income, which are all property problems,” Zhang says in the article. “Real estate is closely related to not only investment, consumption and employment but also local governments’ land revenue and hidden debt problems.”
He says there is room for more cuts in mortgage rates while the People’s Bank of China (PBoC) should allow banks to provide more loans to property developers and homebuyers.
Cailian Press, a Chinese financial website, reported on August 14 that the Guangdong government recently held a high-level meeting with heads of state-owned enterprises and central government-owned firms and senior executives of property developers to discuss how to cope with the growing property crisis.
On August 17, the PBoC said in its second-quarter monetary report that it would fine-tune its lending policies to “adapt to the situation that the supply and demand relations in the property markets have seen major changes.”
It said it will extend its current subsidy scheme until May 2024 to provide property developers with resources to complete their projects and deliver homes to buyers.
It said it will support asset management firms to acquire and revitalize the unfinished projects from some debt-laden property developers.
Read: Chinese wealth management firm stiffs big investors
Follow Jeff Pao on Twitter at @jeffpao3
ReutersProperty giant Evergrande has filed for bankruptcy protection in the US as the real estate crisis in China deepens.
The move comes as problems in China’s property market are adding to concerns about the world’s second largest economy.
China’s economic growth has slowed, exports have fallen and youth unemployment has hit a record high.
Last week, official figures showed the country had slipped into deflation for the first time in more than two years.
China Evergrande Group made the Chapter 15 bankruptcy protection filing in a New York court on Thursday.
Chapter 15 protects the US assets of a foreign company while it works on restructuring its debts.
Evergrande, which defaulted on its debt repayments in 2021, has been working to renegotiate its agreements with creditors.
With an estimated $300bn of debts, it was the world’s most heavily indebted property developer.
At the time, concerns that the firm was on the brink of collapse sent shockwaves through global financial markets.
The company’s Hong Kong-listed shares have been suspended from trading since March 2022.
Evergrande revealed last month that it lost a combined 581.9bn yuan ($80bn; £62.7bn) over the last two years.
Last week, another Chinese property giant, Country Garden, warned that it could see a loss of up to $7.6bn for the first six months of the year.
Earlier this month, Beijing said that China’s economy had slipped into deflation as consumer prices declined in July for the first time in more than two years.
Weak growth means China is not facing the rising prices that have rattled many other countries and prompted central bankers elsewhere to sharply increase borrowing costs.
The country’s imports and exports also fell sharply last month as weaker global demand threatened the recovery prospects of the world’s second-largest economy.
Official figures showed exports fell by 14.5% in July compared with a year earlier, while imports dropped 12.4%.
Earlier this week, China’s central bank unexpectedly cut key interest rates for the second time in three months, in a bid to boost the economy.
Comparing the shakeout of China’s property sector to America’s Great Financial Crisis of 2008 has become a popular meme in the commentariat. Stock markets don’t see it that way: During the 10 months from November through August in 2008, US financial stocks lost half their market value, while Chinese financial stocks have gained 20 percent.
The chart below compares the S&P’s Financials sub-index in the leadup to the GFC (October 31, 2007, through August 15, 2008) to the performance of the financials sub-index of the Shenzhen 300 Index during the same months of 2022-2023.
There is no systemic crisis in China, which has no subprime market, no 5% down mortgages and no “liar’s loans” – the toxic ingredients of America’s toxic 2008 crisis.
China has a different sort of problem: The migration of nearly 700 million Chinese from countryside to city produced history’s greatest land boom, and allowed local governments to fund themselves and their friends with land sales. Real estate ballooned to a quarter of China’s GDP, and lazy capital flowed into the property market.
China’s marginal efficiency of capital (GDP growth per unit of gross fixed capital formation) fell from 0.3% in the 1990s to only .15% in 2020. That’s what Beijing is determined to change.
Xi Jinping’s government in Beijing began tightening lending standards for the property market in 2020, pushing property developers into distress by the middle of 2022. China’s top developers, Evergrande and Country Gardens, have failed to make bond payments. Some trust products – high-interest paper issued by financial institutions with backing by IOUs from property developers and others – have defaulted.
Policy analysts with access to the State Council told Asia Times in Beijing last week that the property market crisis is political.
“Common prosperity” and “Houses are for living, not for speculation” are the populist slogans that the government has put forward, but the underlying issue is simpler: Xi Jinping wants to centralize government finances and impose fiscal discipline on local governments that have lived off the windfall of land prices for the past thirty years.
The central government could push a button and stop the bleeding in the property market whenever it wants. But it won’t let a good crisis go to waste, in Rahm Emmanuel’s phrase.
The State Council is determined to steer China toward a high-tech economy with high rates of return on capital and strong productivity growth, and it will keep the squeeze on the lazy capital of the property market until its political redoubts have been reduced.
To put China’s financial problems in context: There are between RMB 35 trillion and 70 trillion in off-the-books government financing through local government financing vehicles (LGFVs) and other instruments, according to the International Monetary Fund.
Assume an RMB 50 trillion float and an extreme 20% default rate, or RMB 10 trillion of nonpaying bonds. At the current yield of quasi-governmental bonds, that’s RMB 250 billion in skipped coupon payments, or about 1% of China’s central government revenues in 2022.
In an extreme hypothetical case of mass local government defaults, the cost of transferring the cost of debt service to the central government would be trivial compared with overall government revenues.
State-owned enterprises belonging to local governments have estimated assets of about RMB 210 trillion, which can be sold over time to pay down debt. Even assuming a significant drop in property prices, SOE assets more than cover local government debt.
Compare this with the 2008 crisis in the United States, where the market value of about $2 trillion in securitized mortgages and home equity loans fell by more than half, leaving the banks insolvent on a mark-to-market basis.
Regulatory forbearance (ignoring the mark-to-market losses) allowed the banks to work their way out of the hole. Most of the securitized paper continued to pay coupons, and allowed banks to continue to pay interest on the liabilities that funded them.
Mortgage balances in China amount to less than 40% of the value of the financed property, according to the International Monetary Fund. Compare this with the United States in 2008, where the average loan-to-value ratio for conventional single-family mortgages was close to 80%, and nearly 30% of newly-issued mortgages had loan-to-value ratios of more than 90%.
US banks issued 5% down mortgages, zero-interest mortgages, and other highly-levered forms of financing that left homeowners without a cushion when the housing market imploded.
Despite these enormous differences, US think tanks draw parallels to the 2008 crisis. A recent Council on Foreign Relations report states:
A PBoC survey of urban households conducted in 2019 revealed that the value of housing composed 59 percent of households’ total assets, while mortgage loans stood at 12 percent of total assets. These figures are similar to the United States in 2008 on the eve of the subprime mortgage crisis.
That’s true, but misleading: China has no subprime market. It has a small fraction of mortgages issued with a 20% down payment, and an average equity cushion of about 60%.
On Aug. 16, the LGFV market passed a critical test when Tianjin Infrastructure Construction Group sold a RMB 1.5 billion 4.5% six-month note with bids 70 times the offering volume. Bloomberg called this “a sign that Beijing’s fresh efforts to defuse debt risks among regional authorities are reviving demand for such securities.”
Tianjin is the site of China’s first fully-automated port, a marvel of AI applications, and may be a special case, but the takeaway is that the LGFV market remains in full function.
The financial war of attrition between local governments and Beijing will depress China’s GDP growth in the short term, and keep private capital investment subdued for the time being. In an August 14 note to clients, JP Morgan analyst Katherine Lei wrote:
Our base case assumption is that real estate investment will decline by 7.5% in 2023 (vs -10% in 2022) and GDP growth will be 5.0% in 2023. However, the implications of the default events by Country Garden and trusts may be higher than suggested by all the headline estimates.
Some Wall Street analysts recommend taking profits on Chinese bank stocks, worrying that the big state-owned banks might be asked to step in and bail out developers, local government paper or trust products.
That would imply reduced bank profits, but by no means systemic problems for the banks. The volume of interest payments at risk is small relative to the cash flow of the Chinese government.
