The meltdown in China’s property market is dragging the world’s second-largest economy towards stagnation, and should force a reckoning with our dependence on exports. By Mike Seccombe.
China’s insolvency crisis
The Chinese property market is imploding. The question is, will it take Australia, and the world, down with it? And is the Chinese economy – famously the bubble that never bursts – finally doing so?
In the year to June, the value of housing sales in China fell 18 per cent. A month later in July, the fall had accelerated dramatically, to 29 per cent.
And there was a 45 per cent fall, year-on-year, in starts on new housing projects.
Dire as those official figures are, other data suggests far worse. Last month analysts at CLSA, a subsidiary of China’s largest investment bank, CITIC, reported that 28 of China’s largest 100 property developers had either defaulted on their debts or sought extra time to pay. In the first half of this year, they said, property sales had plunged 72 per cent compared with the previous year.
S&P Global Ratings recently warned that about 20 per cent of Chinese developers were at risk of insolvency. According to figures collated in a policy paper and speech by former prime minister Kevin Rudd for the Asia Society Policy Institute, construction of an estimated 13 million apartments has halted. Because about 90 per cent of homes are “pre-sold” – meaning buyers took out loans before construction – that amounts to some four trillion renminbi ($US600 billion) of mortgage debt held on suspended projects.
Those dudded home owners have responded by refusing to make their repayments. As of late July, according to Rudd, more than 300 projects, with a total value of more than $US300 billion, had joined the boycott.
Likewise, thousands of contract suppliers have also begun refusing to pay back loans to the banks, saying they cannot afford to do so until defaulted developers pay them.
The consequences are rippling up through the economy. Local banks have lost cash flow.
“Insolvency risks are therefore growing among China’s nearly 4000 small and medium-sized banks, who collectively hold nearly $US14 trillion in assets,” said Rudd.
And local governments, which on average rely on land sales and related activity for 40 per cent of their revenue, “have also found themselves in serious financial difficulties, facing an expected six trillion RMB ($US900 billion) shortfall in revenues this year.”
Suffice to say the property sector, which accounted for 29 per cent of Chinese GDP at its peak, is in deep and rapidly deepening trouble.
The broader economy appears to be following it down.
China’s economy grew by just 0.4 per cent in the second quarter this year, compared with the same period last year. The target of 5.5 per cent for 2022 – set only in March and pretty modest by historical standards, now looks unattainable. Unemployment, particularly among the young, is shooting up. The central bank has cut interest rates in recent weeks in an attempt to stimulate growth.
“The interest rate cuts, I think, give you an indication that the Chinese government thinks this is really bad. They’ve got, basically, zero growth,” says Professor James Laurenceson, director of the Australia–China Relations Institute at the University of Technology Sydney.
“Youth unemployment is now 19.9 per cent. That’s a really confronting statistic.
“For the last 25 years I have been far more bullish than the average Australian analyst on China’s economy. But when I look at the next six to 12 months, I’m probably more pessimistic about China than I ever have been before,” says Laurenceson.
“There are just so many headwinds hitting the Chinese economy at the moment, and so little effective policy response, I find it hard to be optimistic.”
The proximate cause of the crisis, of course, is the Chinese government’s zero-Covid strategy, and the massive disruption caused by lockdowns in its pursuit.
This presents a challenge unlike any the country has faced before.
In the global financial crisis that started in 2008, says Laurenceson, “we had a collapse in demand and the Chinese government did what the Chinese government usually does, and that’s launch a massive stimulus package focused on infrastructure development.
“But the problem this time is quite different, as is the structure of the Chinese economy. The services sector now – as opposed to back in the GFC period – is by far the largest part of the economy. Last time I checked it was about 55 per cent, and manufacturing only about 30 per cent.
“And it’s the services sector that’s been hit hardest by the Covid lockdowns. It’s really cratering confidence. So you can cut interest rates all you like, but it won’t help much if households don’t want to borrow, because they’re so concerned about their short-term outlook,” he says.
“Sure, the Chinese government could start building bridges and railways and so on, but that’s really not going to help someone who’s had their restaurant shut down.”
Indeed, there’s a strong case to be made that past stimulus – all the bridge and railway building, the over-investment in infrastructure and housing – that preceded Covid has a lot to do with the current crisis.
“It’s a simple story in the sense that they’ve got a massive credit bubble,” says Stephen Joske, a former senior Treasury representative at the Australian embassy in Beijing, who also spent six years advising on markets and macroeconomics for AustralianSuper in Beijing.“The problems actually started in 2008, with the massive stimulus when the global financial crisis started. And then all the debt built up and up. By about 2012 they realised they had a massive debt problem at the local level, as local government entities kept building cities and infrastructure. But they never really fixed it,” he says.
That would likely have induced a recession, in Joske’s view. He says “2015 was a turning point, when they essentially decided to go for growth, not worry so much about the debt”.
But that simply delayed the inevitable.
The common assumption, says Joske, is that China’s debt bubble would not burst, because the central government owns the financial system and therefore controls it.
“But that’s just a real misjudgement about how things work,” he says. “The issue is local government financing vehicles, the local governments building infrastructure.
“If you look at the metrics for China, they’re essentially off the charts. It’s basically in recession.”
He suspects the authorities are “fudging the figures a bit. Still, even the stuff that they’re publishing is pretty horrific. The housing market is the worst it’s ever been.
“You try and sell a house now in Beijing, you just can’t. It doesn’t occur. As in Shanghai. But most of the activity in China is really in the cities we’ve never heard of inland. That is where the real core of the housing market is.”
So the Chinese authorities face an exquisite problem: how to stimulate an economy when excessive stimulus was a major factor in causing the crisis. Then there is the question of how they would spend any stimulus.
Last month, Huang Qifan, vice-chairman of the Financial and Economic Affairs Committee of China’s National People’s Congress, reportedly told Chinese media that new construction should simply cease.
“China has no need for new construction,” he said. The respected American financial journal Barron’s reported him as saying: “Many units are unoccupied investment properties for citizens who already have primary residences, yet China’s population has peaked and will begin to quickly decline. Construction and renovation on public facilities like schools and hospitals have essentially been completed.”
Which brings us to another complicating factor: demographics. Sooner or later, all nations have recessions, but this one comes at a pivotal point for China’s population.
The working-age population peaked almost a decade ago, and now is shrinking rapidly.
As the Lowy Institute’s Roland Rajah and Alyssa Leng noted in a recent analysis, “Revising down the rise of China”, the relaxation of family planning restrictions over the past decade has had little effect.
“The latest national census indicates that the fertility rate has fallen rapidly over the past decade to just 1.3 births per woman in 2020, well below the replacement rate of 2.1. This is broadly in line with the lower-case projections of the United Nations, which suggest that by 2050 China’s working age population will have shrunk by roughly 220 million people,” they said.
That is, nearly 20 per cent. At the same time the non-working population will increase: over-65s will be a quarter of the total by 2050.
Even if the fertility rate were to lift – and there are no indications of that – it would take about 20 years to translate into an increase in available workers. Increasing the retirement age, they suggested, would only add 14-17 million workers.
“Meanwhile, other policy options such as improving access to child- and aged-care services to encourage women to stay in the workforce must contend with the fact that China’s female labour force participation rate is already abnormally high, suggesting further substantial increase may be difficult,” they said.
Demographic decline, coupled with declining rates of productivity and the “limits of [debt-fuelled] capital-intensive growth”, would see China’s economy grow yearly by only about 3 per cent by 2030 and average 2-3 per cent to 2050, even if things went well.
Their report came out in March; since then it has become starkly clear things are not going well.
In his comprehensive survey of the Chinese economic landscape, Rudd noted China’s poor performance on productivity was “the single-most important long-term factor of all”, particularly since the ascension of its autocratic current president, Xi Jinping.
“China’s annual rate of improvement in total factor productivity (the best measure of long-term economic development) averaged an impressive 22 per cent between 2003 and 2011, but declined sharply to a mere 5 between 2011 and 2019, after Xi took power. In the view of many analysts, this decline likely continued to accelerate significantly after 2020 to less than 2 per cent.”
Rudd also cited damning figures on the accelerating flight of foreign capital from China. The value of financial assets in China held by foreigners fell by more than $US150 billion in the first quarter of 2022 – the single biggest drop ever recorded, he said.
“According to a forecast by the Institute of International Finance, some $US300 billion in capital will likely flow out of China this year, up from $US129 billion in 2021.”
There is another big problem facing China: climate and the environment.
Like much of the northern hemisphere, it has suffered unprecedented heat and drought this year. Rivers are drying up, including parts of the Yangtze. This has had a significant impact on agriculture and the transportation of goods. More significantly, says Tim Buckley, energy analyst and director of the think tank Climate Energy Finance, it has resulted in power shortages.
“Hydro is 20 per cent of power generation in China, that’s huge. But because of the lack of water, hydro production in July was down 20 per cent,” says Buckley.
As a result, major manufacturers have had to curtail operations – including, ironically, some producers of solar cells, “because polysilicon is just molten electricity. And so all of a sudden, the cost of modules is going up.”
As too, ironically, is coal consumption, even though coal production is very water-intensive. And while the current record drought will probably eventually break, China’s water crisis is ongoing. Water is simply being pumped from rivers and underground faster than it can be replenished. Furthermore, much of it is contaminated by farm and industrial chemicals – groundwater in particular. Almost a third of China’s groundwater has been officially declared unfit for human consumption, and 16 per cent unfit for any use at all.
So China has plenty of problems. And because of China’s size and importance to the global economy, those problems will not be easily contained.
In April, the International Monetary Fund forecast Chinese economic growth of just 4.4 per cent this year. In July it cut that sharply, to 3.3 per cent, and on recent indications that may still prove optimistic.
The IMF also revised down its forecast for global growth from 3.6 to 3.2 per cent, citing a range of factors, prominent among them the Chinese crisis. It acknowledged that “risks to the outlook are overwhelmingly tilted to the downside”, and warned “renewed Covid-19 outbreaks and lockdowns as well as a further escalation of the property sector crisis might further suppress Chinese growth”. And therefore global growth.
Of course, not all countries are affected equally by China’s problems.
“It’s really interesting,” says Professor David Goodman, director of the China Studies Centre at Sydney University, “that despite all the hoo-ha over ‘war’ with Taiwan, there’s been no let-up so far in the trade between Taiwan and PRC, over [computer] chip manufacturing – or indeed anything else. Trade is pretty much the same. And Taiwan is the major investor of all political entities into China.”
Laurenceson, too, suggests “some of the geopolitical angst seen in many Western capitals” as somewhat “overwrought”.
“Australian attention has focused on an armed conflict in the Taiwan Strait but a higher probability negative event involving China is an economic one.”
As Goodman says, there are only two places in the world that have major trade surpluses with China. Taiwan is one. The other one is Australia.
So what about us?
The knock-on effect, Goodman says, could be “quite severe, because our economy depends on resources exports to China so they can process them. And that ain’t going to happen whilst the economy there is slowing down.”
It depends on how quickly China resumes normal operations, and particularly what happens with the Covid lockdowns.
Goodman notes that China’s party leadership meets every August, ahead of the National People’s Congress. “All the runes, if you like, seem to suggest that the local authorities are being asked to ease up on restrictions, and to put economic development at the forefront. To get things restarted again, as quickly as possible.”
Whether they succeed is quite another matter. Getting things moving again, he says, is “like turning around an ocean liner. It takes time.”
So far, Australia has not suffered from China’s economic problems, says Laurenceson.
Judging by the first-half trade figures for this year, “it looks like we’re heading towards either another record high in terms of total exports, or very close to it,” he says.
“The complementarities between the Chinese and Australian economy really are deep. That is, for many goods that China needs, we are the most reliable and competitive supplier by a good margin. That basic value proposition cuts across resources and agriculture, perhaps less so services. Still, Australian exporters would be right to worry.
“Resource prices, they’re getting a massive boost at the moment. But I don’t see that as being sustainable.”
Nor does Joske, and for the same reason: Chinese demand will simply not be there in the future. The long supercycle for commodities will have to end.
“With a shrinking population, entire provincial cities are going to basically start emptying out, and at a national level it’s going to be very hard sustaining much growth at all,” he says.
There are suggestions it could happen sooner rather than later. Just this week The Australian Financial Review reported a forecast by the Commonwealth Bank of a 40 per cent fall of key Australian commodity prices between March this year and next year.
Now, that may prove wrong, or China may bounce back, but the longer-term picture for China – and therefore for us, unless we diversify – is not looking rosy.
As Kevin Rudd warned: “There is a very real chance that China will now grow old before it grows rich.”
This article was first published in the print edition of The Saturday Paper on August 27, 2022 as "China’s insolvency crisis".
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