Chancellor: Evergrande is all of China’s woes in one
LONDON, September 30 (Reuters Breakingviews) – Former Chinese Premier Wen Jiabao called China’s economy “unstable, unbalanced, uncoordinated and unsustainable” 14 years ago. It’s unclear if he predicted that China would one day be plagued by a huge real estate bubble, overinvestment, excessive debt accumulation and a wobbly credit system – but it did come to fruition. China Evergrande (3333.HK), the stricken Chinese real estate developer, has long existed at the intersection of these imbalances. read more By defeating Evergrande, President Xi Jinping has shown that he intends to seize nettle. As the Chinese economic bubble deflates, it will be replaced by a new economic system under Xi’s absolute command.
Prior to the global financial crisis, China’s growth was driven by surging exports and related investments in factories and manufacturing. After the Lehman Brothers bankruptcy, Beijing launched a massive stimulus package, financed by borrowed money. Over the following years, the Chinese economy was driven by ever greater doses of investment and credit. The country’s real estate market was at the center of this boom. After surviving many setbacks, Chinese real estate has gained a reputation for invincibility. As the title of a recent book suggests, it was the “bubble that never bursts”.
Unlike most senior Chinese politicians, Xi was not fascinated by the boom in the real estate market. Real estate booms generate low-quality or “fictitious” growth, he said. In recent years, returns on investment in China have collapsed and productivity growth (output per capita) has fallen to half of its 2007 level. Xi also called the real estate boom a source of social division. Land use planning fueled public corruption, which Xi was trying to root out. Rising house prices have deepened inequalities – about half of the world’s real estate billionaires come from the People’s Republic – and have excluded young people from the market. Millions of properties owned by investors have gone vacant.
Last year, the pandemic pushed the Chinese housing market into high gear. At this point, Beijing has released its “three red lines” limiting the use of leverage by developers. These new rules ultimately brought Evergrande to the brink. Home sales recently collapsed. It is a risky move. The value of China’s real estate stock is around 3.7 times the GDP, according to Stewart Paterson of Capital Dialectics. Much of China’s debt is secured by real estate. Almost a third of economic activity is exposed, directly or indirectly, to real estate development.
No country has ever deflated a real estate bubble without experiencing a serious economic downturn, often accompanied by a financial crisis. There are parallels with the Japanese economic bubble that burst three decades ago. The total value of Chinese property (relative to GDP) is roughly equal to that of Japanese real estate at its peak in 1990. Credit growth in China was more extreme than that of Japan in the 1980s. After Tokyo raised interest rates to unleash its speculative frenzy, a severe banking crisis ensued and the economy suffered a “lost decade”. At the same time, the decline of the Japanese labor force exacerbated the deflationary forces triggered by the collapse of the bubble. China is now facing a similar situation.
Beijing believes, however, to be in a better position than Tokyo to deal with the fallout. Developers controlled by state and local governments will likely take over housing projects from Evergrande and other private developers. Contract law will not determine how bad debts are sorted. Instead, non-performing loans will be mixed around China’s opaque credit system, with authorities deciding who absorbs the losses. It helps that the People’s Republic has relatively limited exposure to foreign creditors.
The Chinese economy is sure to slow down as the bubble lets air out. It is often said that the legitimacy of the Communist Party government depends on which party provides economic growth. But the current party secretary general is more interested in “resilience” and “common prosperity” than in achieving GDP targets. Its primary objective is not economic but national “rejuvenation”. In pursuit of these goals, Xi is prepared to sacrifice immediate economic growth. Its political position is strong enough to support the vested interests that will suffer the most from the collapse.
Besides, Xi has a vision for the future. Its China 2025 Economic Development Plan aims to establish Chinese dominance in a variety of new technologies, from artificial intelligence to robotics. A social credit system, which rewards and punishes the behavior of citizens, will complement conventional credit. There is no place for cryptos in this world. Instead, a digital yuan issued by the central bank will complement, and possibly even replace, conventional currency. The country’s economic structure, currently built on bricks and mortar, will become more digital. Big data, powered by the internet and the hundreds of millions of public cameras, will support Xi’s surveillance firm.
Western investors have plenty to chew on. The immediate impact of the housing slowdown is deflationary. China’s abandonment of investment-led growth will reduce global demand for raw materials. If the PBOC prints money to alleviate debt problems, as seems likely, the yuan could take a hit on forex. Capital flight could put additional pressure on the currency. But if China throws cheap surpluses on the rest of the world, trade tensions are sure to resurface.
China is becoming a more dangerous place for foreign investors. Beijing’s recent treatment of listed tech companies and education companies shows that every Chinese company must put state interests ahead of shareholders. As bad debt problems emerge, foreign creditors will find themselves at the back of the pack. Tellingly, when Evergrande last week missed a payment to foreign creditors, it was reported that interest owed on its domestic debt had been renegotiated.
The period of “reform and opening up” that began with Deng Xiaoping’s reforms in the late 1970s rekindled the “Chinese Dream” – the long-held notion that demand from the huge population of the country would generate vast profits for foreigners. This dream is now dead. In his place, Xi speaks of the “Chinese Dream,” a collectivist project that exalts the nation-state and places the party he leads under total control. Socialism with Chinese characteristics is starting to look a lot like old-fashioned communism. Except this time, its technology is more advanced.
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Editing by Rob Cox and Katrina Hamlin
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