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There are serious challenges in China’s property market and local government debt, but the Chinese government is capable of solving them, according to expert analysts.
However, it will take years to resolve these deepseated problems, which will meanwhile hurt other sectors of the Chinese economy, they said. And this week on December 5, rating agency Moody's downgraded the outlook of China's credit ratings to negative from stable citing structural concerns in the economy inlcuding local governmenr debt, slower growth and the downsizing in the property sector.
Debt for the central government is a small issue, but for some local governments, it may take five years or more to resolve their debt problems, an analyst with a US investment advisory told FinanceAsia.
“Local governments depend on too much of their income coming from land sales revenue. In extreme cases, land sales revenue could account for two thirds of yearly fiscal budget. But local governments have a lot of state-owned assets, which are ignored by most watchers. Therefore, if Beijing can jumpstart a bull market of Chinese stocks, that will in turn lead to a revaluation of such state-owned assets. Local governments can sell just a fraction of these assets to reduce their debt levels,” said the analyst who declined to be named.
“It is not easy to solve the debt problem, and I believe will take years or even decades to fully solve all of them. I believe it would take at least two to three years to calm down the market, but the effect of the liquidated assets may take a much longer time for the market to absorb,” an executive of a Hong Kong property advisory firm told FA.
The problems in China’s property market have spread not just to the banking sector, but to many other industries such as the financial industry, construction industry and materials’ suppliers, said the executive who declined to be named.
“The Chinese government is aware of the problems, and they are taking steps to resolve them, but I think they need to put out more policies or even capital to help the private sector, otherwise the existing policies may not be powerful enough,” the executive added.
China’s economy is underperforming its full potential, said Weijian Shan, executive chairman and co-founder of PAG, an Asia-focused investment firm.
“China is not without its economic challenges. There are good reasons for business and consumer sentiment to be weak and confidence low at the moment. It will take a couple of years of policy stability and concrete policy support for the private sector to fully regain confidence,” Shan said at PAG’s conference in Hong Kong on November 8.
Beijing is avoiding a central government solution to its property crisis and is leaving the majority of the debt adjustment in the hands of local governments, wrote Andrew Collier in a report of Global Sources Partners, a US macroeconomic and geopolitical research firm, on November 10. Beijing only steps in when things get bad enough to cause protests or a collapse of a large bank or developer, wrote Collier, managing director of Orient Capital Research, a Hong Kong economic research firm.
“This is going to result in a drawn-out process. Some provinces will resort to a “fortress” mentality, protecting their state sector and whatever jobs are left. Others, lacking the resources to help state firms, will force the adjustment onto private entrepreneurs, who will struggle to obtain capital to stay in business,” Collier predicted.
“The main point is there will be many workout types. Only over several years will we know what the main patterns are,” Collier added.
The Chinese government is trying ot balance the turmoil while also supporting growth.
A Moody’s report on November 14 said, “China’s policymakers face substantial challenges in their approach to the property market downturn as they have to manage a smooth and gradual deleveraging and ensure financial systemic risk is contained while supporting economic growth. Authorities have become more selective in their willingness to provide support to the sector compared with previous periods of aggressive stimulus, such as in 2015.”
In China, lower policy support means developers and property buyers are more uncertain about the future for property sales and prices respectively, said the Moody’s report. “This increases the risk that the property downturn may be more protracted than the authorities expect.”
China’s total local government debt is close to Rmb100 trillion ($13.8 trillion), Willy Lam, a senior fellow of the Jamestown Foundation, a US think tank, told FA. “No government can handle this monster.”
China's Xi Jinping can only hope to restructure the loans and task state-owned banks and state-owned enterprises to share the debt load for 20 or so years, Lam said.
The government is also struggling to raise new funds and to attract more investment.
“Where does the money come from? From January to September, China only absorbed $125.75 billion of foreign direct investment (FDI), a fall of 8.4% over same time in 2022. The last quarter saw the first quarter since Deng’s reform when the country registered negative FDI,” Lam added.
One example of this trend is Vanguard, a US mutual fund company which manages $7.8 trillion of assets, is exiting from China, a Vanguard spokesman confirmed to FA. Vanguard will support its joint venture in Shanghai through December and close its Shanghai office thereafter, the Vanguard spokesman said. Vanguard has not ruled out other business opportunities in China in future, the spokesman clarified.
Property problems
In China, property developers’ contract sales worsened in October, said a Nomura report on October 31. According to the China Real Estate Information Corporation (CRIC), growth in contract sales volume for the top 100 developers in China fell by 35.7% year-on-year in October, which was a greater decline than from 34.1% contraction in September.
In China, property sales are below their 2021 peak, said an S&P Global report on October 23. The S&P report gave a 20% probability that, assuming a decline of 20 to 25% in property sales in 2024, China’s GDP growth will fall to 2.9% next year. The Chinese government is targeting a GDP growth of 5% this year.
On a more positive note, in November, the International Monetary Fund (IMF) recently unpdated China’s growth forecast for 2023 to 5.4% from 5%. Growth could slow to 4.6% in 2024, but this was an upgrade from a 4.2% expectation in October.
The Chinese government plans to issue Rmb1 trillion of central government bonds this quarter, but the impact of this bond issue may be quite small, said a Nomura report on November 13. It stated: “We still hold the belief that growth stabilisation is not solid as the property and export sectors continue to contract. We believe Beijing needs to be bolder in rescuing the property sector and cleaning up local government debt to secure a more sustainable recovery.”
Glimmer of hope
“Will the slump in the housing sector lead to a financial crisis as it did in the US and Europe in 2008? Many pundits have rung the alarm by calling the troubles facing the distressed property developer Evergrande, “China’s Lehman moment” – referring to the demise of the once venerated American bank which triggered the 2008 Financial Crisis. But the answer is no,” said Shan at the PAG conference.
The average loan to value ratio of mortgages in China’s major cities is about 40%, which means housing prices will have to fall more than half to produce negative equity for homeowners, Shan explained. “That is not even remotely likely to happen.”
China’s balance sheet shows positive financial net worth, whereas other countries such as the US, Japan and Germany are deeply in negative territory, Shan pointed out. Assuming the highest debt-to-GDP ratio of 110% for China’s overall government debt, it still compares favourably with that of the US federal government which is about 140% of GDP and with Japan’s central government debt of about 260% of GDP, Shan explained. Furthermore, the financial assets owned by the Chinese government exceed its total financial liabilities, Shan said.
“China’s economic fundamentals are sound; its government has ample policy space to tackle its current economic slowdown; and its industrial development has positioned it well for the future. All of this is to say that China’s growth, despite the naysayers, will likely continue for the foreseeable future,” said Shan.
And in another positive sign this week, on December 5, the closely watched Chinese services sector expanded ahead of analyst expectations at 51.5, the highest in three months and signalling firming demand in the economy.
