Confidence tumbles as China's property crisis spreads, plus Biden steps up chip curbs, escalating tech war & China's pro-Palestine talk is destroying ties with Israel -- China Boss News 10.20.23
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What happened.
Anxiety over exposure to China Evergrande Group was already high.
But when the company announced last month that its founder and chairman “had been detained on suspicion of crimes,” investors and analysts began to think Evergrande's "multi billion-dollar restructuring plan might be in peril," CNN said.
If the firm that "helped to urbanize large sections of the country" had to be liquidated, a wide swathe of creditors would get hurt.
Last week, depositors in China’s northern Hebei province began withdrawing their savings from a local government-controlled bank.
Rumors that “the Bank of Cangzhou had lent billions of yuan in loans to Evergrande” mushroomed so quickly on social media the government’s censors couldn't block them all. Many posts linked to a “document” also “circulating online” that “purport[ed] to show the amount of money the developer owes to banks in China."
As withdrawals gathered pace, local officials dispatched police to fend off panicked customers and urged everyone “to make rational judgments.”
“The bank’s operations are ‘sound,’ and its customers [are] protected by the national deposit insurance scheme,” an official notice at the bank's entrance said.
Around the same time as the run on the Bank of Cangzhou, Country Garden, China's biggest private property developer, warned it was running out of cash.
Since then, a “$15 million coupon payment deadline has expired without word of payment,” according to Reuters.
The amount, due yesterday, wouldn’t have made much of a dent in the nearly $200 billion that Country Garden now owes its creditors.
Like Evergrande, the company also owes billions offshore, away from Beijing’s power to "cram-down" any restructuring over creditors’ rights and objections.
But unlike Evergrande, KT Capital Group's Fern Wang cautioned, it had been Beijing's 'better child' - "meet[ing] all three of the debt ratio requirements introduced in 2021" whereas Evergrande had flunked each and every one.
“The company has almost $11 billion of offshore bonds and a default would set the stage for one of China's biggest corporate debt restructurings,” Reuters said.
Why it matters
Cross defaults and restructurings
Country Garden’s default will also set off a wave of cross-defaults in its other bonds which is a boilerplate condition of commercial bond contracts.
“Investors are haunted by memories of the 2021 fallout in Asia’s high-yield bond markets and equities that followed a default by Evergrande. The hit this time would be much larger. Country Garden has four times the number of housing projects as Evergrande,” Financial Times’ analysts said.
Another risk is that the behemoth's gargantuan subsidiaries can't be "ring fenced," either externally in a cross-border bankruptcy or internally by Beijing, to shield them from Country Garden’s overwhelming liabilities.
Note that Chinese officials have issued a slew of recent measures geared toward rescuing its property sector - from extending a 2022 rescue package and approving guidelines for the planning and construction of new investment to permitting favorable lending rates to high risk borrowers and cutting reserves and benchmark lending rates to boost liquidity.
However, none them seem to be working. While the "pace of contraction has slowed” this month, according another Reuters update, "China's property sales and investment posted double-digit declines.”
At the same time, China’s top leaders did do something rather remarkable, although it didn’t get a lot of attention in the press. They quietly omitted Xi Jinping’s phrase "housing are for living in, not for speculation" in the official readout of the Politburo’s meeting last June, suggesting another tweak on policy.
Still, the "conventional wisdom" that China cannot have a severe financial crisis "might be dangerously out of date," Wall Street Journal's Chief Economics Commentator Greg Ip wrote this week.
“China’s fiscal and financial imbalances are so large that they have taken the country—and, because of its size, the world—into uncharted territory. We simply don’t know how well the Chinese economy, and a leadership now concentrated in the hands of President Xi Jinping, can navigate these strains,” Ip said.
Feedback loops
The financial health of China's local governments, more so than Beijing’s, is the concern.
Their inability to service debt had the attention of the International Monetary Fund last week at its annual meeting with the World Bank in Marrakesh. IMF analysts worried that their “boosted projections of Chinese government deficits, which they now see swelling from 7.1% of gross domestic product this year to 7.8% in 2028” might become "a big problem for China's banks, which hold roughly 80% of that debt.”
“There’s also the potential for feedback loops: As loan losses mount, banks lend less. Local governments, unable to borrow, slash investment and social services. Economic growth and property values weaken further,” WSJ’s IP said.
After the initial reform period of the 1970’s to 2000’s, “China should have dramatically lowered the share of production it reinvested" into infrastructure, according to Michael Pettis, an expert on China’s economy and professor of finance at Peking University’s Guanghua School of Management.
But it didn’t because “to do so without causing a sharp drop in the growth of economic activity required rebalancing the economy toward greater consumption, which in turn meant transferring income from previously successful parts of the economy to the household sector.” That’s “household,” as in consumers, not “housing” as in property developers or investors.
The result was that “the country’s financial system had to be underpinned by implicit moral hazard” - where fast-and-loose property developers, banks, and investors took outsized risks on the assumption that, as an inextricably intertwined unit, they were “too big too fail.”
Then came Xi and his desire to - once and for all - tame, if not kill the beast.
The "problem" then, as Bloomberg’s Shuli Ren back in 2021 put it, was that the developers didn't take the Chinese leader seriously, because “[t]he government never quite loosened its home purchase policies despite President Xi Jinping talking up his mantra of ‘housing is to be lived in, not speculated on’ way back in December 2016.”
A sense of invincibility took root, and leveraging climbed even higher.
“So most of those willing to live dangerously survived, and continue to live dangerously. Moral hazard has become such a big problem that some developers believe they are immortal,” Ren said.
Fast forward to 2023 and there are new signs that local and global confidence in China’s “capable technocrats” are sinking alongside the country’s property market.
Gary Meng, who “invested $300,000 in Evergrande’s wealth management arm and is still owed $194,000,” recently told the New York Times he used to have faith “in the government and the party and the country.”
“Now I can only say that I am quite bitterly disappointed,” Mr. Meng said.
IMF Chief Pierre-Olivier Gourinchas agreed that “China’s real estate crisis was undermining confidence and causing financial difficulties.”
“The problem is serious,” he stressed to other policymakers in Marrakesh.
Logan Wright, director of China research at Rhodium Group, a research firm, told WSJ’s IP that “a financial crisis in China” would be more likely to occur “when investors who assumed the government stood behind their assets learn that it doesn’t.
“The property sector was previously considered too big to fail, until Beijing’s own policy priorities were suddenly perceived differently,” he warned.
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