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Weekly Comic: China Treads a Nervous Path Between Twin Threats


By Geoffrey Smith –It can be easy to lose sight of it, but whether the number of Russian soldiers that ends up permanently in Ukraine is zero, or 100,000, or anywhere in between, the big risk to the global economy this year remains China.

The world’s second-largest economy has to pick a difficult path between the twin risks of Covid-19 and a slow-motion real estate bust: deadening the economy with lockdowns on the one hand, while supporting it with easier monetary and prudential policy on the other.

A clear slowdown looks inevitable. As western governments withdraw their stimulus measures and reopen their economies, the dramatic shift in global demand since 2020 toward manufactured goods (mostly made in China) will reverse. The country notched 29.9% export growth last year, generating yet another record trade surplus. That is not sustainable.

China needs its global customers to take the strain off its manufacturing sector, not least because its zero-tolerance Covid-19 leaves perilously little margin for safety in the global supply chains it feeds. Reported case numbers are now falling, and the much-publicized lockdown in the city of Xi’an has now been lifted, but Omicron is so contagious that the upcoming Lunar New Year celebrations still carry an obvious risk of spreading it more broadly across the country. 

At the same time, the real estate sector that has been the other big driver of economic growth over recent years is also slowing. While the authorities have managed to avoid disorderly defaults in the sector, they have been less successful in creating the kind of conditions needed to ensure that fundamentally sound companies can still find credit. At 11.6%, outstanding loans to the economy are growing at their slowest annual rate in 20 years.

Markets cheered in December when a committee dominated by state-owned institutions took control of debt restructuring talks at Evergrande, the country’s largest and most indebted developer, thinking that clear political direction would accelerate the cleanup and quickly bring clarity back to the sector.

However, that hasn’t happened. Evergrande’s international creditors said last week they will start to enforce their rights against the company after being ignored by the company for weeks, complaining of a “lack of engagement and opaque decision-making…contrary to well established international standards in restructuring processes of this magnitude.”

A public letter from the creditors suggests that there will be little left over for them once Evergrande’s politically well-connected restructuring committee has hacked off the juiciest bits of the carcass. “Barely a few days pass without another news story or regulatory announcement disclosing yet further and hitherto undisclosed liabilities, pledges, asset sales and dispositions and/or government appropriations,” the creditors said.

Small wonder that international bond markets remain closed to Chinese developers. The lack of refinancing alternatives is generating a steady drip of default notices – Hong Kong-listed Yuzhou Properties (HK:1628) becoming the latest to say it will fail to meet its obligations.

The authorities are at least trying to compensate by making domestic financing conditions easier. The People’s Bank of China cut a suite of benchmark interest rates over the last week and talked up the possibility of doing more. It has the room to do so because inflation is falling, both for consumers and for manufacturers (in stark contrast to western economies). The yuan, meanwhile, is in rude health, reaching its highest in nearly four years.

Chinese markets may remain susceptible to other shocks, such as the regulators’ campaign against the country’s biggest Internet companies last year. But the authorities have succeeded in avoiding disaster, both with the pandemic and its property developers, in a way that many western nations haven’t. For companies and investors in Europe and the U.S. who depend on that stability continuing, that’s good news.

Weekly Comic: China Treads a Nervous Path Between Twin Threats

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