This is a re-post of Article originally published on Pundit.co.nz. It is here with permission.
The recent financial failures of two Chinese property giants, Evergrande and Country Garden, which at various times ranked second and sixth in size in China, have had implications for the New Zealand economy.
Evergrande Group has been struggling since 2021 (here). She has just filed with a New York court for Chapter 15, the US bankruptcy protection law that enables her to restructure her debts. Estimates indicate that the debt – most of which is not American – amounts to US$300 billion (say, NZ$500 billion). One assessment concluded that its liquidation in February 2022 would return only 0% to 10% of the loan principal to creditors.
Also in August 2023, Country Garden defaulted on US$45 million in respect of interest payments linked to two US dollar offshore bonds. I won’t talk about all the turmoil that has happened since then, but I’ll sum it up by saying that today’s Country Park looks like it’s located where Evergrande was two years ago. It may decline faster because Evergrande has undermined financial market confidence.
Moreover, although many Chinese real estate companies are not prominent in the news, many of them – some of them relatively large – are also experiencing increasingly difficult financial problems. China has many “shadow” banks, which are banks that are not regulated in the usual way and that have the potential to collapse the entire financial system.
The immediate factor was that in August 2020, the Chinese government enacted the “three red lines” rule that regulated the leverage used by real estate developers by limiting their borrowing based on the following metrics: debt to cash, debt to equity, and debt to assets. The purpose of the rule was to rein in the debt-laden real estate development sector. This happened, but at the cost of undermining many of them. By October 2021, 14 of China’s 30 largest developers had violated regulations at least once.
More importantly, there was a speculative real estate boom that began more than a decade ago, as companies relied on inflating real estate prices in order to “balance” their books. It was a type of fraudulent financing, exacerbated by local authorities financing themselves by selling land to companies, which financed the sale from cash flow coming from new investors and banks.
Because of local authority involvement, companies have been building accommodation in tier III and IV cities, where there is not much demand. There are pictures of rows of apartment buildings that are said to be completely empty. They will be listed on the company’s books at cost plus inflation, but there is little chance they will be sold at those prices, if they can be sold at all.
Note also that a rapidly growing company – anywhere in the world – is unlikely to develop strict internal systems to manage and monitor itself. Only after the recipients move on will we learn how lax the failed company was (and how corrupt it was).
I believe that the central authorities saw that the boom was not sustainable, and that the longer the collapse was delayed, the greater it would be. So they figured it would be better to act soon, even if it caused turmoil in China’s real estate and financial markets.
There is a lot to gather or guess. But the issue in this column is the impact on New Zealand and the world.
There is general agreement that financial instability may politically weaken Chinese Prime Minister Xi Jiang. At the very least, it requires him to pay more attention to internal issues. Among the issues sure to concern Xi and the Central Committee are demonstrations outside Evergrande’s offices by investors who partly paid for housing that was never built or finished, and by subcontractors who have not been paid. The demonstrators may turn against the government.
This does not mean that China will cease to be politically important in the international system. It’s too big and important for that. Indeed, there is an uncomfortable possibility that it will become more aggressive on the external level in an attempt to divert its people’s attention from failed internal issues. (Putin’s Russia is a contemporary example, but history records many other examples.)
Moreover, the real estate sector is said to contribute 24% to 30% of China’s GDP. The turmoil in the real estate market appears to be contributing to the slowdown in the growth of the Chinese economy, which gives Xi less room for economic maneuver; This may slow down its commitment to the Belt and Road Initiative.
(The other big driver of Chinese growth has been export, and this too has been experiencing a hiccup, partly because the global economy is slowing and partly because many countries are trying to wean themselves off their dependence on China. The gains from their prosperity are also likely to be curtailed. The export sector is not growing as quickly as been on for the past few decades).
One assumes that the government in Beijing will eventually bail out China’s real estate sector (and the local authorities and banks that finance it). There are different ways to compare the size of the Chinese and New Zealand economies; Someone says it’s about 70 times bigger. So Evergrande’s NZ$500 billion debt is equivalent to about $7 billion here. (Do we double it for other real estate companies that will collapse too?) Our Treasury and Reserve Bank would fail a bailout of this size. (I have more confidence in their experience doing rescues; they’ve had more practice. They won’t have to deal with the shadow banking system.)
Will China’s financial turmoil significantly impact the global financial system? Conventional wisdom is that the exposure is not great. There may be some non-Chinese financial institutions that are overexposed and will suffer – and perhaps even collapse – but they are assumed to constitute a small proportion of the total.
New Zealand’s biggest concern is whether the slow growth of the Chinese economy will affect our exports there. Our trade dependence on China is extraordinary. It is the largest market for dairy products, sheep meat (second only to beef), fish, apples, wine and honey (third to kiwifruit). Thirty years ago, China was not among the top ten destinations for New Zealand’s exports in any of these products. We may already be seeing the impact of slower growth in global dairy prices.
We have long been aware of our over-export dependence on China, which has been exacerbated by selling to other markets in East and Southeast Asia (including Australia) that are themselves highly dependent on the Chinese economy. (Exports to these markets account for about two-thirds of our total exports; China alone accounts for a third.)
There have been major efforts to diversify. We have just settled free trade agreements with Britain and the European Union. The big diversification might be with India, but the Indians were not as enthusiastic as us. After all, compared to others they are negotiating with, we are just a small child. The deal was a “priority” for the Key-English government, it was for Ardern and Hipkins, and National has declared it will be for them. There’s a bit of a pattern here, isn’t there? When we finally get a free trade agreement, there will likely be a slight improvement in access to dairy products.
We are negotiating trade deals that will add to diversification: with the “Pacific Alliance” – the Latin American regional grouping made up of Chile, Colombia, Mexico and Peru – and with the Gulf states – Saudi Arabia, the UAE, Qatar and the UAE. Kuwait, Oman and Bahrain. Negotiations with a customs union between Russia, Belarus, and Kazakhstan are currently on hold, while the long-term ambition of a free trade agreement with the United States is not on the table. Open multilateral deals enable new members to join, as happened when Britain joined the Trans-Pacific Partnership, increasing diversification; Existing bilateral trade agreements are also being updated.
This may mean that China and associated economies will continue to dominate New Zealand’s economic outlook for some time to come. What happens in China’s real estate and finance markets may be more important to us than the October 2023 elections.
* Brian Easton, an independent researcher, is an economist, social statistician, public policy analyst, and historian. He was the the listener Economics columnist from 1978 to 2014. This is a repost of Article originally published on Pundit.co.nz. It is here with permission.