Anyone following the financial papers cannot have failed to read lurid reports regarding China’s Evergrande construction company, which appears on the brink of collapse.
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Chinese markets fall on Evergrande crisis
Indeed, stock markets in China took a heavy fall this week on news that the world’s most indebted construction firm could fail to repay interest coupons due this week and next.
Evergrande was valued at $41 billion in 2020. However, its market capitalization fell to just $3.7 billion now, as it became apparent the highly leveraged company with total liabilities of some $300 billion was struggling to repay a modest onshore interest debt this week.
Evergrande’s woes are merely the symptom of a much bigger problem.
As the Financial Times notes, China’s vast real estate sector, which contributes some 29% of the country’s gross domestic product, is so overbuilt that rather than leading as China’s prime driver of economic growth, it is fast becoming a drag on it.
According to the Financial Times, there is enough empty property in China to house over 90 million people. To put that in perspective, there are five G7 countries – France, Germany, Italy, the U.K. and Canada — that could fit their entire populations into those empty Chinese apartments, with room to spare.
Oversupply has been a problem for several years. But after much prevarication, President Xi Jinping has formulated three red lines to reduce debt levels in the sector. While by no means the only perpetrator, Evergrande has failed all three red lines. Those lines are the ratio of liabilities to assets, of net debt to equity, and cash to short-term debt.
However, it is simply the first and largest to be thrown to the wolves as an example to the rest.
China’s property market woes
China’s property market is a problem on multiple levels.
While it has been a reliable dynamo for economic growth in the past, demographics are working against it for the decade to come.
China’s population is barely growing. In 2020, only 12 million babies were born, down from 14.65 million a year earlier. That figure is predicted to drop below 10 million in the years ahead.
Put simply, China’s largest engine of growth is building properties for which there is no market. In the process, it is consuming capital and creating winners and losers in a real estate lottery.
A significant portion of China’s steel industry exists simply to serve the construction sector.
Capacity totaling hundreds of millions of tons has grown up producing rebar and construction steels for a market that is already oversupplied with partially constructed projects. The property sector accounts for some 20% of China’s copper consumption. It also accounts for 10% of its nickel demand.
As Beijing tightens the screws on lending to property companies, national GDP growth will slow. In turn, so will metals consumption.
In the decade from 2000 to 2009, China’s GDP growth averaged 10.4% a year. Meanwhile, during the decade from 2010 to 2019, annual GDP still grew by an average of 7.68%. Growth this decade will struggle to exceed 4%. It could average just 1-2% in the second half of this decade, the Financial Times suggests.
While Evergrande’s collapse, should it come to that, is unlikely to become another Lehman moment, the knock-on effect could still be significant.
Land sales are a significant source of income for local government. Sales fell 90% year over year in the first 12 days of September. Real estate firms tried to dump properties and hold projects in the face of the escalating crisis. Property sales fell 16% in the first half of September. That followed a 20% decline in August.
Other property groups also appear at risk.
According to The Economist, quoting UBS, 10 other Chinese property groups with 1.86 trillion RMB ($290 billion) in contracted sales are in similarly risky positions.
Beijing desperately wants to move its growth model from property to high technology manufacturing and the deployment of green technologies. However, that transition is unlikely to be smooth, even in a centrally controlled economy like China’s.
In the meantime, metals are beginning to react to the writing on the wall. Iron ore had already been in decline due to restrictions on steel production. Hence, demand for the steelmaking raw material has fallen, bringing the price below $100 per ton. That is half the level it reached earlier this year.
Could China’s property market, for so long the engine of global metal demand, become the force that ends the current metals boom?
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