China is in the headlines again, this time because of the threatened implosion of a real estate development company, inauspiciously called Evergrande.
Evergrande is the second-largest real estate development company in China by revenue. Estimates are that real estate and related activities account for about 30% of China’s GDP, so this is arguably the largest sector of the economy.
China is the second-largest economy in the world in dollar terms and was the largest contributor to global GDP and trade growth in the past 20 years. In summary, the second-grandest company in the grandest sector in the grandest economy in the world is failing. This is a systemic event for the global economy.
Unfortunately, Evergrande is symptomatic of the pressures now facing the real estate sector in China. The sector needs to shrink. Whether this happens slowly or abruptly will depend on whether Chinese authorities are able to deliver the soft landing they have been trying unsuccessfully to engineer for the better part of a decade. Unfortunately, history suggests this is a very tall order. Debt-fuelled real estate bubbles always come to an inglorious end.
Moreover, the challenge extends beyond real estate. For some time now China has been trying to rebalance its economy away from the debt-fuelled, investment-led growth model. Even then, private sector debt has grown to just more than 180% of GDP in 2020 from 100% in 2008. According to World Bank data, this is the highest level of private sector debt in the world.
The banks in China are state-owned, which makes this less of a risk for financial market stability. However, no balance sheet can pile on dead assets forever. At some point the banks will stop or slow lending and investors will have to accept that the assets on corporate books are not worth what the companies say they are.
At best, lending and investment will slow down to allow productivity and occupancies to catch up. At worst, corporate defaults will soar. The latter eventuality would lead to unpleasant contagion across financial markets and the real economy in China and across the globe. Chinese authorities are trying to arrest runaway credit growth and decelerate growth in an orderly fashion. For all our sakes, I hope they succeed, but I have my doubts.
While this transition is happening, Chinese growth will necessarily slow down and the overhang of risk and uncertainty will persist. Can the country transition without huge disruption to the global financial system along the way? What negative feedback loops could yet develop? What does this mean for the global growth model, which is powered by assumptions of increasing trade and globalisation, with China at the centre?
What about the commodity exporting countries whose growth has been so tied to continuous Chinese fixed investment growth? What happens to European countries, whose growth has been linked to Chinese demand for high value imports?
SA is unfortunately highly exposed to the China growth story, indirectly via its implications for global financial markets and the global economy, and directly via the fact that China is SA’s most important trading partner. The loss of momentum in the Chinese economy in the decade to 2020 contributed a lot to the drag on the domestic economy over the period. As we now know, the resulting economic stagnation has been catastrophic for the political economy. This “not” Evergrande disaster is a signal that the next decade will be an unhappy one for China, and policymakers had better take heed.
At the very least, we must assume that the current frothiness in commodity prices might not persist, and that the positive terms of trade shock that we have enjoyed of late could become a negative shock in the coming period. This could portend the re-emergence of macroeconomic pressures over the medium term. The need for structural reforms has only become more urgent in the past two weeks.
• Lijane works in fixed income sales and strategy at Absa Corporate & Investment Banking.
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