Tuesday, July 3, 2018

CHINESE BUBBLE ...WAR WITHIN CHINA


The Chinese economy is going to face some hard days as the following reasons are grappling the economic growth engines to slow down, overheating in its real-estate sector, a roller-coaster stock market, and a rapidly growing shadow-banking sector. The battle is within the Chinese economy now more compared to US economy  These segments have been one of the key growth contributors for the Chinese GDP but now these factors are now being narrowed down to get the economy into a sustainable economic growth.  My Fear is only the bubble burst and not the rules of presently controlling the bubble. My article will accentuate these lines where prices are controlled but constructions are being supported. This would be a disaster for the Chinese economy in the long term.

Chinese real estate market is similar like US where bubbles were created. From June 2015 through the end of last year, the 100 City Price Index, published by SouFun Holdings, rose 31 percent to nearly $202 per square foot. That’s 38 percent higher than the median price per square foot in the US, where per capita income is more than 700 percent higher than in China. This is the very reason why China imposed many rules to control the bubble. They increased down payment requirements, tightened mortgage restrictions, banned the resale of property for several years, and limited the number of homes that people can buy.  But the restrictions have lead minimal effect currently based upon the data. Loans for individual purchases grew 20 percent year on year to reach 22.86 trillion yuan, with the growth rate declining 2.2 percent, as compared to the last quarter of 2017.

But the loan to developers is a significant threat. According to the data as of mid-2017, the volume of real-estate related loans at listed Chinese banks stood at 22.6 trillion yuan (approx. USD$3.59 trillion) as compared to 12.88 trillion in mid-2014, for an increase of over 75%. This is the very reason why banks are being restricted in the use of bank loans or trust funds to invest in the real estate market.

China’s real-estate sector accounts for an estimated 15% of GDP and 20% of the national demand for loans. The industry players have significant debt to equity ratio where many of the player's ratios go beyond 250%. The below chart depicts the name of the ones who are having a significant threat to the economy.



The rental market is not at all supportive for the rental as wages are low in China. Developers rent to consumers to make a 1.5 percent yield while paying a combined debt-and-equity cost of capital of almost 10 percent. This is a big gap and hence only buyers are the solution and excess construction has created a bubble. Rental markets will never grow and neither can be expected to be supportive of the Chinese real estate industry.

But I don’t find that there is any slowdown in the bubble formation. Based on the data new land purchase and the start of real estate projects have grown strongly in last 5 month of 2018. Investment in the residential real estate is up 14 percent and development loans are up 21 percent. Banks are again very actively getting into the speculative bubbles and mortgage growth is now 20%. This is a significant threat and I can promise more money and more avenues will open for this sector in the long term to balance the US trade restriction and investments. Long tenures of loans and another type of benefits will be doled out to balance the economy from the other side.

China has come up with a new set of rules for its real estate market to control prices speculation but how strong the same would be is a question mark. Enterprise buyers have to meet certain requirements including based in the city for five years or longer, paying a tax of at least one million yuan ($156,490), and hiring 10 or more employees with their accumulation fund and social insurance records of five years. Enterprises paying five million yuan tax are excluded. Further, the enterprises will be prohibited to resell the homes for five years instead of three years. This policy is curbing speculation. But my fear is speculation which already has been built will start coming down and that will create an immense problem for the Chinese economy. Those who are betting on the wealthy Chinese population, well they are buying more outside of China rather within China.

Funding restrictions are going to fail since many real estate developers are looking ahead for Mezzanine debt is a hybrid of debt and equity financing that gives the lender the right to convert to an equity interest in the company in case of default, after other senior lenders are paid. Hence a substantial growth in M&A will come up in the Chinese economy as many developers will lookout for offshore funding and getting into JV so as long-term period could be achieved. The developers want to wait for the removal of price caps and other restrictions as the current US trade war might force the Chinese officials to remove the restrictions and create the bubble further.

According to the data the US trade restrictions have created a serious mark on the Chinese economy and its a matter of concern for the 2nd largest economy and the rest of Asian economy. According to the sources, the recent economic data cast a deep shadow over the growth of manufacturing of the Chinese economy and the upcoming slowdown for the Chinese economy. In a brief statement, the General Administration of Customs said growth in China’s US-bound shipments slowed to 5.4 percent in the first six months from 19.3 percent a year earlier. June export growth was even slower at 3.8 percent, down 23.8 percentage points from the same time in 2017, the administration said.

If the export sector is going to face slowdown then other economic sectors will be given leeway or it will be total collapse based on the measures of cleaning the economy. The battle is within Chinese economy to balance its growth. I think China might be an example in the books of economics were chasing growth based on the export of an asset bubble, both turn into a nightmare.

These bubbles were being managed through various avenues but now with trade restrictions and US export market being turning into dry ground china will have to figure out new ways of economic growth. The construction industry will have to suffer a major setback at any point of time even if the funding restrictions are being removed keeping to balance the current economic growth based on US trade restrictions.

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