Chinese property’s “glory days are firmly behind it”

Pantheon Macroeconomics with the note:

  • Early Chinese data point to a stabilisation—at low levels— of economic activity.
  • Infrastructure investment likely rose in November, partially offsetting the property slowdown.
  • Prepare for a harsher crackdown on the private sector in 2022, and more infrastructure spending.

Slow and Steady in November as Policymakers Double Down

A November stabilisation is on the cards for China. Early signals from the PMIs, trade, and most recently, money and credit data, all look hopeful. A sharp rebound it is not, but it looks like the tried-and tested lever of infrastructure is being pulled, once again. Policy support is being stepped up, both on the fiscal and monetary side, as the latest RRR cut demonstrates, but don’t mistake this for a full reversal. The property sector’s glory days are firmly behind it, and to paraphrase the PBoC, floodlike stimulus is not on the horizon.

Credit growth picked up for the first time in nine months in November, albeit marginally, rising to 10.1% year-over-year from 10.0% in October. Still, this looks like a turning point in the downward trend prompted by the ‘Three Red Lines’ crackdown on property developer borrowing. Bank lending, however, has continued to decelerate, and shadow financing
continues to shrink; this is not driven by risk appetite, positive sentiment, or a more laissez-faire central bank. Rather, the headline improvement is driven entirely by government and corporate bond issuance, with the latter matching reports of large increases in SOE developer borrowing. The state is intervening to put a floor under the credit cycle, and so to cushion
the fall in growth.

Another positive sign was the November increase in M1 growth, to 3.0% year-over-year, from 2.8% in October, breaking a streak of declines. Given M2 growth slowed, this implies an increase in demand deposits relative to time deposits, a sign of money being put to work. Early data show a drop in government deposits, after a surge in October, but a further  breakdown is lacking at this point. Our working assumption is that local governments have pulled the trigger on infrastructure investments, drawing down deposits and putting the cash into the coffers of the corporate sector, boosting M1 growth. Rising import volumes of iron and copper, and an increase in November’s construction PMI  reinforce this conviction, and lead us to expect a small bounce in infrastructure FAI in this week’s data.

The main pushback we receive to this view is that the commodity imports and stronger construction activity reflect a property sector recovery, driven by government capitulation. We think this is unlikely. Most policy easing has focused on loosening mortgage restrictions, and expanding channels for developers to access credit, principally by improving access to bond markets. It has not changed the ‘Three Red Lines’, so developers still face hard limits on debt growth, and are still under significant pressure when these limits are coupled with collapsing sales.  Similarly, you can ease mortgages all you want, but buyers will be hesitant when confronted with falling prices, and a looming property tax.

What about all this bond issuance then, surely a sign of renewed investment by stronger developers?

Again, we doubt it. Instead, we think developers are building war chests either to acquire assets at steep discounts from their more troubled brethren, or else to see them through 2022. The sector faces around $84B in onshore and offshore debt maturing over the year, per press reports. For most, this is not the time to embark on ambitious new construction projects. SOE developers are also under pressure to support land auctions, as the private sector opts out, and so some of their bond proceeds will ultimately be rerouted to local governments, who are more likely to spend it on infrastructure than property.

We still think that FAI growth will slow in November, to 5.4% year-over-year from 6.1% in October. Support from  infrastructure will not be enough fully to offset the large probable slowdown in property, alongside a smaller decline for manufacturing. The rate of decline will lessen, however, after some steep falls earlier in the year. A boost to infrastructure should provide an extra fillip to industrial production, already lifted by the full restoration of electricity supplies, accelerating growth to 3.9% year-over-year in November, from 3.5% in October. Have no illusions though, this is still a terrible number by Chinese standards. Retail sales will likely slow, given the usual seasonal pattern around Singles’ Day; better to focus on the three month average growth rate, for now.

Evergrande finally defaults

In a timely reminder that the property sector remains extremely shaky, China’s second largest developer by sales was placed in restricted default by rating agency Fitch on December 9, after apparently failing to make coupon payments at the end of a grace period on December 6. The firm now has Guangdong government officials ensconced in its offices, who will be making sure domestic creditors are repaid first. The initial fallout has been modest, with much of the damage already done, given how well telegraphed this outcome has been. Dollar borrowing costs rose again for Chinese developers, but as yet there have been no additional failures linked to Evergrande.

Unfortunately, with $84B in debt coming due next year, this is scant comfort. Further failures are inevitable; fellow developer Kaisa has already also been placed in default.

Other damage will also not be immediate, but this does not mean it can be ignored. Shadow finance is already under pressure, as visible in our first chart, and default by Evergrande and others will add to this. Bloomberg reports three firms with $5 B in high yield products linked to the developer have already notified clients of probable missed payments. Given the overlapping and opaque nature of WMPs, we can expect this to spread through the system and drag on credit in 2022. Banks also face greater uncertainty now, as they wait to see the impact of cross-default clauses on their property sector exposure, typically 30% or more of loan books, and a big chunk of collateral. Further state support for the credit impulse will be needed.

Evergrande’s failure will also put into doubt payments to other creditors, not only bond investors. Over 8000 firms are thought to be connected to Evergrande, either as suppliers or agents, and will have big question marks over their future revenue streams. For Beijing, this represents a risk to social stability, because it will inevitably result in layoffs.
Pressure is already building on this front, as our chart above shows. Strikes related to layoffs and wage arrears are on the rise, though subdued relative to historical levels. A separate series on calls for help, where workers ask for government assistance officially or unofficially, rather than striking, shows a similar upward trend. Unfortunately, this series has a shorter
history, but should be less distorted than strike action by fear of punishment, which can vary over time.

Policymakers signal more of the same in 2022

The RRR cut showed a degree of concern from policymakers, even if the PBoC seemingly had to be nudged into it, see here. But it does not mean a volte-face is coming. The 2021 Central Economic Work Conference—a key meeting for China watchers hopeful for a steer on policy intentions—concluded on December 10, and reiterated that “houses are for living in, not speculation”. Monetary policy will be flexible and appropriate, and its fiscal counterpart, effective and targeted. The days of providing stimulus via the property sector are over.

Instead, a promise to “properly advance infrastructure investment” suggests the direction of travel is another old favourite. 2022 should therefore see an increase in the bond quota for local governments, after it was cut in 2021. The housing market will “better meet household demand”; code, we think, for a continuation of existing policies and a greater state role in the sector. As SOEs hoover up the remnants of Evergrande and others, we expect a pivot by the sector to providing more affordable housing, in line with previous speeches by President Xi.

The SME sector is also set for more support, in the form of further tax and fee reductions, and targeted easing by the PBoC. The private sector more broadly, however, is still set for a torrid time. Language about preventing the “barbaric growth of capital” is harsher than in previous policy discussions, and suggests an accordingly stricter stance from China’s regulators.
Crackdowns on larger private sector firms, including tech and finance, have further to go.

Unconventional Economist

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