In this market pulse, we delve into the complex terrain of China's property debt overhang, examining the challenges faced by giants like Evergrande. We also assess the current economic momentum, highlighted by positive indicators and upcoming Purchasing Managers' Index (PMI) data releases. Moreover, we emphasize the pivotal role of impending crucial meetings, including the Third Plenary Session and the 6th National Financial Work Conference, in shaping China's economic policies.
Key Points:
- Examining the enormity of China's property debt crisis, including Evergrande's challenges.
- Highlighting recent signs of recovery and the significance of the upcoming PMI data.
- Previewing the upcoming Third Plenary Session and 6th National Financial Work Conference.
Introduction
China Evergrande's ongoing financial troubles and defaults have once again taken center stage, casting a dark cloud over the equity market. Meanwhile, China's economic recovery is showing signs of life, with attention turning to key economic indicators like the Purchasing Managers' Index (PMI). In addition to these economic developments, several crucial meetings on China's economic and financial policies are on the horizon. This article will delve into these topics, providing an analysis of the current situation and what lies ahead.
China Property Developer Debt Overhang
China Evergrande, one of the nation's largest property developers, has recently made headlines due to its inability to meet regulatory qualifications for issuing new debt. This situation escalated when its mainland unit, Hengda Real Estate Group, failed to make a scheduled payment of RMB4 billion in principal and interest.
The broader issue here is the massive debt overhang in the Chinese property sector, totaling RMB60 trillion. A significant portion of this debt, RMB40 trillion, consists of mortgage debts that are relatively less risky for banks as long as the pre-sold units are completed and delivered to buyers. The focus for Chinese authorities is to resolve these pre-sold units to ensure contractors get paid and homebuyers receive their properties. The completion of unfinished housing projects requires substantially additional funds, estimated to be over RMB2 trillion, which may be shared by state-owned enterprises that take over the projects, local governments, and the central government.
However, the more problematic area is the RMB20 trillion in property developer debts. It's highly unlikely that China will bail out insolvent property developers. Instead, these developers and their banks will likely sell encumbered projects, along with their loans, to stronger entities, often state-owned enterprises with government backing. The recent regulatory easing on housing demand may stabilize the housing market to some extent. Still, the overhang of housing inventories in lower-tier cities facing population decline will persist for several years. This will lead to more headlines about defaults, restructuring, and liquidation of insolvent developers, causing losses for shareholders, bondholders, banks, and investors in trust and wealth management products tied to property projects.
Some trust companies and private equity funds in the shadow banking sector may be subject to losses detrimental to their financial viability. While the banking sector, which holds around 75% of the RMB20 trillion developer debts, has sufficient capital buffers to absorb losses, the extent of the impact will depend on the successful liquidation of housing inventories by insolvent developers to stronger entities, likely brokered by local governments. This process is expected to negatively affect the profitability of banks in China.
Economic Momentum and PMI Data
Recent economic indicators have shown signs of improvement in the Chinese economy. The Citi China Economic Surprise Index (Figure 1) has rebounded, indicating fewer instances of economic data falling below expectations. As discussed in last week's Market Pulse note, retail sales, industrial production, trade, and inflation data improved in August.
The release today of a bounce in August industrial profit growth to 17.2% YoY (Figure 2), the first monthly year-on-year growth since June of last year, provides additional support for the pick-up in growth found in the industrial production released last week.