The collapse of highly leveraged debt-backed financial instruments, particularly those in the US which packaged subprime mortgages and other risky assets, sparked that economic conflagration.
As local governments in some areas of China – often the far northeast and parts of the southwest – are collecting less revenue from land sales due to the property slump, they will have less money for investment in large infrastructure projects. This will, in turn, cramp jobs, consumption and retail further, analysts said.
“Though a financial or debt crisis is nearly impossible, local government financing stress could affect local economies in a very negative way,” said Liang Yan, chair professor of economics at Willamette University in the US state of Oregon.
That stress, Liang said, reduces infrastructure outlays, social programme spending and help for local businesses. “All these could weaken local economies, including foreign businesses, directly in reduced support and indirectly as impaired consumer demand,” she said.
“The banks are in the firing line for local government debt problems,” said Christopher Beddor, deputy director of China research at Gavekal Dragonomics in Hong Kong.
“If a local government financing vehicle (LGFV) encounters debt distress, among the very first things that local officials will do is lean on banks to restructure loans to the vehicle,” he said. “This practice impacts the earnings and equity of nearly all the banks, including the ‘big four’.”
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Anger mounts as China’s property debt crisis leaves flats unfinished
Anger mounts as China’s property debt crisis leaves flats unfinished
A bond default by a LGFV – a company that borrows in the name of a locality, mostly for infrastructure – would risk “financial contagion” if capital markets in turn blocked other vehicles and state-owned enterprises, Beddor said. “If that happened, there would absolutely be some panic selling because the government guarantee would be abruptly undermined.”
But analysts call severe spillover scenarios unlikely.
From an overseas perspective, default risks are low because onshore debt is semipublic and denominated in yuan, while the offshore debt of US$33 billion that will mature this year is “a very small amount”, Liang said. The weakest 10 Chinese provinces account for at most 18 per cent of LGFV debt, and “only a small portion of the debt needs some form of restructuring”, she added.
Since last year, local governments have been allowed to swap high-interest debt with lower-interest bonds. Attempts have also been made to control the amount of new debt local vehicles are allowed to take out.
Individual offshore investors say they’re not worried about a spillover – if they are thinking about it at all.
Financial markets have priced in property downturn risks and central government measures have been effective in preventing any large-scale defaults, said Clifford Lau, a Singapore-based currency portfolio manager at William Blair.
“The probability of triggering a confidence crisis is there, but we feel it is not high at this juncture,” Lau said.
Jeff Bowman, the chief executive officer of US-based materials science firm Cocona, visited China in May to meet several customers. He said none mentioned problems getting loans and that two “proudly showed off” recent, “large” capital investments.
Cocona makes a sweat-drying additive for yarn, and about half of it ships to Chinese spinners. About a quarter of the firm’s annual revenues, US$10 million to US$20 million, comes from China.
“I have not been paying much attention to the ongoing property situation in China, as the situation has been obvious for years without having reached crisis mode,” Bowman said.
Stephen Pau, chief investment officer of Hefeng Family Office – a management firm that handles the assets of wealthy families – sees the Chinese property market “stabilising” with government backing.
“The large state-owned banks are expected to withstand these pressures, with the expectation of strong sovereign support if needed,” said the Hong Kong-based Pau.