China’s Contagion fears spread

China’s Contagion fears spread

In economics & finance, a contagion can be explained as a situation where a shock in a particular economy or region spreads out and affects others by way of price movements.

JPMorgan ramped up its 2023 global emerging market corporate high yield (HY) default rate forecast to 9.7% from 6% following the latest wave of problems in China’s property sector. JPM said Chinese property firms were expected to account for nearly 40% of 2023’s corporate default volumes, followed by 35% from Russia and 12% from Brazil. Anxiety about contagion risks is spreading through global markets, putting China's government under mounting?pressure?to deliver support for the ailing real estate sector, which accounts for 30-40% of economy.

China’s Real Estate crisis

·????????The property sector, which has accounted for over 30 % of Chinese growth for years, has been hit by the imposition of much stricter regulatory measures.

·????????The property bubble has “popped”, leading to knock-on.

·????????The median home price in Beijing can be as high as 25 times the average annual income (New York is up to 10 times).

·????????The real estate sector has suffered tumbling sales, tight liquidity and a series of developer defaults since late 2021, with China Evergrande Group?at the centre of the debt crisis.

·????????Markets, investors and home buyers fear the worst.

·????????Real Estate sector’s potential collapse has generated worries about systemic financial risk.

·????????70 % of household savings are in real estate

·????????JPMorgan estimates that around 50 property developers have defaulted on $100 billion of offshore bonds over the last 2 years

China's largest private real estate developer Country Garden?is seeking to delay payment on a private onshore bond for the first time, the latest sign of a stifling cash crunch in the property sector, piling pressure on Beijing to step in. If Country Garden suffers a full-scale default, it would add $9.9 billion; it would also take the China property default tally to $17 billion and add to the $100 billion of defaults already seen. Once considered a more financially sound developer, Country Garden's woes could also have a chilling effect on homebuyers and financial firms, with more private developers close to a?tipping point?if Beijing's support does not materialise soon. Country Garden’s losses are mounting. It has said it expects to report a loss of as much as $7.6 billion in the first six months of the year. Even if people were still buying Country Garden’s apartments, they would not be able to buy enough of them to make up the financial shortfall, experts said. Besides, who wants to buy an apartment from a company that might not be around to finish building it? A year ago, Country Garden was a model corporate citizen in an expanding universe of?delinquent?real estate companies that borrowed recklessly and then stopped paying their bills. Country Garden, founded by Yang Guoqiang in 1992, was a beneficiary of the world’s biggest real estate boom. Its success turned Mr. Yang into a?billionaire?and became a testament to the country’s remarkable growth. Chinese people, having few other reliable options to build wealth, invested their incomes and savings in real estate. Like other big private developers, Country Garden kept borrowing and often borrowed more to pay back its loans, operating on the assumption that as long as it continued to expand, it could keep repaying its debt.

The Country Garden default could be as influential as Evergrande simply because it is so huge.

Debt & Financial Crisis

·????????China’s $23 trillion local debt Trap (Infra led)

·????????$15.3 trillion local government debt crisis looms in China

·????????China’s Debt-to-GDP Ratio Rises to Record 279.7% on Credit Boom

Borrowing often sits in local-government-financing vehicles (LGFVs), firms set up by officials to dodge rules which restrict their ability to borrow. These entities’ outstanding bonds reached 13.6trn Yuan ($2trn), or about 40% of China’s corporate-bond market, at the end of last year. Lending through opaque, unofficial channels means that, in reality, debts are considerably higher

Beijing has been pushing local governments to curb debt risks for years, especially the “hidden” kind — referring to debt raised by financing vehicles on behalf of municipalities, but which doesn’t show up on the balance sheets of the localities.

Adding to worries about contagion risk, a major Chinese trust company that traditionally had sizable exposure to real estate, Zhongrong International Trust Co, has missed its repayment obligations on some investment products. Analysts warned that a rise in default by trust companies, also known as shadow banks, which have strong ties to the domestic property sector, will further weigh on the world's second-largest economy. Trust firms, or shadow banks, operate outside many of the rules that govern banks, channeling the proceeds of wealth products sold by banks to developers and other sectors that are unable to tap bank funding directly.

Concerns about the outsized exposure of China's shadow banks - a $3 trillion industry, to property developers have grown over the past year as the sector lurched from one crisis to another.

Wealth-management products, though providing higher yields than standard deposits, faced a 5% decline in value by 2022's end, as per Fitch Ratings. Around two-thirds of these products are comprised of bonds, indicating possible redemption pressures persisting through 2023.

China’s Economy in Crisis mode, China reports big data miss in July

??Retail sales, a key gauge of consumption, rose by 2.5% in July from a year ago (down from 3.1% in June), below expectations for a 4.5% increase.

??Industrial production rose by 3.7% in July from a year ago (down from 4.4% in June), below the 4.4% increase analysts had expected.

??Fixed asset investment rose by 3.4% for the first seven months of the year from a year ago, below the 3.8% forecast by the experts.

??Chinese Economy is in deflation, which can trigger a recession and create a ‘doom loop’

??China headed for a lost decade, similar to Japan in 1990s (period of slow or negative growth)

??China is big. What happens to the world's 2nd largest economy turns ripples into waves

??Reduced manufacturing on the back of weak international demand - has resulted in fewer exports, fewer Chinese-made goods available worldwide and less business activity in Asia's mega factory. Then the subsequent slower consumption in China means fewer imports of other countries' products

??Rising costs, Covid lockdowns & decoupling pressure in the West have forced some foreign-funded manufacturers to relocate operations

??Weak overseas demand, tepid domestic consumption and persistent problems in the property sector have been major factors in China's struggles to mount a solid post-COVID recovery.

??China has had the biggest monetary expansion in human history over the past 15 years, and its M2 money supply is by far the largest in the world (nearly double that of the US)

??By Mar’23, China’s M2 had soared to US$40.84trn – far larger than the US (US$20.84trn)

The recent data suggests?China?may struggle to achieve a 5% growth target set for the year. The world’s second-largest economy grew just 0.8% between the first and second quarters of 2023, according to official figures.

Chinese leaders have sought to boost domestic consumption, with the State Council releasing a 20-point plan to encourage citizens to spend more in sectors including vehicles, tourism & home appliances. The country’s top leaders have warned that the economy faces “new difficulties and challenges” as well as “hidden dangers in key areas”.

Youth unemployment crisis

·????????The unemployment rate among 16- to 24-year-olds in urban areas hit 21.3 %, a record, in June.

·????????Chinese professor estimates youth jobless rate might have hit 46.5%

·????????A record 11.58 million university graduates are expected to enter the Chinese jobs market this year.

·????????Companies are hesitating to hire, taking a "wait-and- see" attitude

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China suspends youth unemployment report, facing an expected seventh consecutive monthly increase in youth unemployment. It has risen every month this year and was widely forecast to have climbed further last month. China’s decision could exacerbate concerns from investors and executives who say that tightening government control of information is making it harder to do business there. The announcement drew more than 140 million views on Weibo, one of the biggest social media platforms in China, within hours. Many people commenting said that they believed Beijing was trying to hide negative information, and others said the public had the right to be informed. Release of figures suspended in order to ‘optimise labour force survey statistics’. While this decision aims to refine data collection methods, it has sparked skepticism among the public.

Given its size, China's slowdown is having a domino effect in other areas too,

Large scale youth unemployment coupled with losses in their investments & savings could spark protests amongst urban youths, totally unheard in China.

Biden called China's economy a "ticking time bomb." and gave an ominous warning about the potential for China to do “bad things” (escalating tensions with Taiwan) during difficult economic times.

Conclusions

China’s economy is slipping in Recession from current stage of deflation. This can get further complicated with very high local Debt which could threaten stability of Chinese Banking and in turn Savings from Chinese savers. This situation is similar to what Japan has experienced for last 3 decades and thus China is staring at lost decades. All of this is happening at a time when the stakes are especially high for President Xi Jinping as he tries to rule China as autocratic leader. Remember, USSR faced similar economic collapse before they disintegrated.

CA Harshad Shah, Mumbai [email protected]

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