Trading links between South Africa and China have grown significantly in recent years, increasing the risk that economic issues within China could have material knock-on consequences for our local economy. Given this, it makes sense for South African investors to keep a close eye on mounting credit risks being observed within China’s property market.
Introduction
A stalled Evergrande development has kicked off a potential credit crisis in the Chinese Property market. The contagion has origins from December 2021 when the China Evergrande group was officially labelled a defaulter for the first time. Credit risk is mounting in the Chinese economy because of the mortgage payment boycotts that kicked off in late June of 2022. It has since grown to 301 projects in 91 cities and threatens to derail the attempt to revive the Chinese economy. Suppliers to real estate developers were refusing to repay bank loans because they have unpaid bills owed to them. Homebuyers refused to pay mortgages because of a widespread practice in China of selling apartments before they are built. In the past year, the overleveraged developer’s market has been in crisis mode over debt repayments as funds ran dry, and construction has stopped on more projects. (Zachariahs, 2022)
Credit Risks
Chinese banks assess the risk from the housing loan non-repayment as controllable and they have so far disclosed 2.1 billion Yuan (which is converted to about $311million) of credit risk. However, an independent financial services company in China expects that as much as 2 trillion Yuan ($297 billion) of mortgages are at risk because of the boycotts. Overall, the banks sit on 38 trillion Yuan ($5.6trillion) of outstanding residential mortgages, and 13 trillion Yuan ($ 1.9trillion) of loans are attributed to the beleaguered developers. (Zachariahs, 2022)
Proposed Government Intervention
When the boycotts began and fears started to rise in the market late in June, Chinese authorities considered allowing homeowners to temporarily halt mortgage payments on stalled projects without incurring penalties. This was aimed at preventing a crisis of confidence in the housing market from boiling over. There was a yet-to-be-finalised proposal from financial regulators, where hundreds of thousands of home buyers would be allowed to pause their payments without an impact on their credit scores. This was part of a broader push to stabilize the property market and included urging local governments and banks to plug some of the funding shortages at developers. (Zachariahs, 2022) (Monahan, 2022)
The stakes are high for the Chinese government as about 70% of the country’s household wealth is stored in the property market, along with 30-40% of the bank’s loan book, while land sales account for 30-40% of Chinese government revenue. The boycotts have elevated stresses in China’s credit market and dragged down commodities in the process. (Lau, 2022)
As of the 30th of September 2022, China’s financial regulators said that state owned banks would need to extend about 600 billion Yuan ($84 million) of net financing. The Peoples Bank of China (PBOC) and the China Banking and Insurance Regulatory Commission told six of the largest banks to each offer 100 billion Yuan of financing support, while the central bank unveiled a rare tax incentive for homebuyers, where people buying a new residence within a year of selling their old ones would qualify for an income tax refund. (Zhu, 2022)
Contagion
Evergrande is yet to reach an agreement with its international bondholders over a restructuring proposal. The real estate developer has over $300billion in liabilities and defaulted on its U.S. dollar denominated bonds in December 2021 following months of liquidity problems. The property developer missed a self-imposed July deadline to provide a restructuring plan. It was reported at the end of August 2022 that bondholders pushed their own plan for restructuring. They suggested that the chair at Evergrande buy new shares issued by the company and use the capital to repay its offshore debts.
Before the conglomerate was engulfed in a liquidity crisis, it was China’s largest developer. It borrowed aggressively from the dollar debt market to help with its expansion, becoming Asia’s largest junk-bond issuer. Evergrande had avoided defaulting on its onshore debt, but on July 8th it was unable to make interest and principal payments on its yuan-denominated bond. (Saeedy, Ng, & Hirtenstein, 2022)
On the other hand, homeowners are anxious after making down payments on projects by developers where construction has since stopped or is not completed on schedule. The property market, which was previously booming, has experienced more than a year of sliding apartments sales, falling home sales, and dozens of developer bond defaults. Evergrande, like many of its peers, presold many unfinished apartments and promised to deliver them in a few years. (Monahan, 2022)
Economic Conditions
The economy is showing tentative signs of stabilisation with Covid-19 restrictions being lifted. The Chinese economy is forecasted to expand 3.5% Q/Q in 3Q2022 and 2.0% Q/Q in the 4th quarter of 2022. The economy is expected to expand by 3.5% for the full year of 2022 and 5.2% for the full year of 2023. The probability of a recession happening in the next 12-months is estimated at 20%. In the 2Q of 2022, GDP was forecast to decrease by 1.5% quarter on quarter compared to a prior quarter-on-quarter increase of 0%, however actual GDP increased slightly by 0.4% in the second quarter.
CPI is expected to average at 2.3% y/y in 2022. China’s actual CPI was reported at 2.8% in September from a prior of 2.5% in August of 2022. Third quarter GDP numbers were delayed as of the 17th of October and authorities didn’t provide a reason. (Li, 2022)
PBOC held its benchmark lending rates steady at their October meeting; the one-year loan prime rate was left unchanged at 3.65%. The 5-year Loan Prime Rate (LPR), a reference rate for mortgages was maintained at 4.30%. The decision to leave the LPR unchanged follows the central bank’s decision to maintain policies that help to spur borrowing. China will be cautious in unleashing further stimulus to preserve policy room. PBoC and Chinese leaders have highlighted concerns over high inflation from overseas and signaled reluctance to lower interest rates given ample liquidity in the interbank market. Rate hikes in the US and Europe limit China’s ability to ease monetary policy because that would risk capital outflows. (Seria, 2022) As of the 19th of October it was reported that the Chinese central bank is conducting reverse repos to the value of 2billion Yuan (about $280.94 million). The central bank is purchasing securities to keep liquidity stable in the banking system.
What do we see as a likely impact on our local markets?
Over the last two decades, China has significantly increased its trading partnerships on the African continent. African farm exports to China increased 18% year-on-year in 2021 and China is now the second largest destination for African farm exports (Times, 2021). China is also a significant importer of South African gold, with 15,000kg of non-monetary gold imported in June of 2022.
The emergence of China as a major trading partner for Africa increases the risk that issues within the Chinese economy will have knock-on consequences for our local economy. If China is unable to control the market sentiment around this housing market crisis, then it is likely that our currency will weaken (via reduced commodity exports to China). Furthermore, interest rates will likely be negatively impacted by flow driven sentiment. We further believe investors’ lack of risk appetite could potentially push yields on longer-dated bonds higher, as our GDP potential in South Africa would decline if China’s GDP declines. So far Chinese GDP is surprising to the upside.
China has been Africa’s largest trading partner for 12 years since 2009 and the proportion of Africa’s trade with China has continued to rise. The value of trade between Africa and China rose 35% in 2021 from 2020, mainly due to an increase in Chinese exports to the continent. The value of Sino-African trade is estimated at $200 billion per year.
Conclusion
Understanding the risks that the international markets pose to the local economy makes for better investment decision making. Globally investors have been diligently assessing the risks to the developments in the Chinese property market. The potential ripple effect due to the stresses in the property market in China is a real one.
Disclaimer
The information and content contained in this article is provided for general informational purposes only. It does not constitute financial or investment advice. Although Prowess Investment Managers has taken care to ensure that the content of this article is accurate and fairly presented, Prowess Investment Managers cannot be held responsible for any inaccuracies in the information contained.