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China’s property market is facing a “sharp deterioration” which could lead to financial stress domestically, and ultimately affect its trade with Australia.
Key points:
- Evergrande is facing liquidation proceedings on October 30
- Police have detained its chairman and founder Hui Ka Yan
- The company has been blocked from raising new debt to fund its survival
That is one of the key risks, identified by the Reserve Bank of Australia in its latest financial stability review, in a chapter specifically about the “vulnerabilities in China’s financial system”.
The RBA warned that problems stemming from the “sharp deterioration” in China’s property sector — which accounts for about 30 per cent of the nation’s economic growth — could lead to a global slowdown, weaker commodity prices and “reduced Chinese imports of Australian goods and services”.
It comes as China’s major property developers, like Evergrande, appear to be on the brink of collapse once again.
Evergrande became the poster child of China’s debt-fuelled property crisis when it was revealed in 2021 that it owes investors more than $US300 billion, which it is still struggling to repay.
This led to speculation that its downfall would result in some “contagion” effect as China’s entire property development sector struggles to pay off its massive debts.
The situation has worsened significantly for Evergrande in the past month, with allegations of criminal conduct against its current and former executives, and more deadlines missed for repaying its debt.
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Fall from grace
In late September, Evergrande filed a statement to Hong Kong’s stock exchange, confirming that its chairman and founder Hui Ka Yan was facing “mandatory measures in accordance with the law due to suspicion of illegal crimes”.
Essentially, Mr Hui was detained by Chinese police earlier that month and placed under residential surveillance.
“It shows the government is trying to take a very harsh stance on some of those who have profited for many years from the over-leveraging of the company,” said Jun Bei Liu, portfolio manager at Tribeca Investment Partners.
“The government certainly seems like it wants someone to be held responsible for that.”
However, he is not the only person from the company in legal trouble.
Police also arrested an undisclosed number of employees at Evergrande’s wealth management division in the southern city of Shenzhen last month.
In addition, its former chief financial officer Pan Darong and ex-CEO Xia Haijun have been detained by Chinese authorities, according to a report by financial news site Caixin, though no official explanation has been provided for their detention.
Mr Hui used to be Asia’s richest person at the height of China’s property bubble. The 64-year-old property tycoon’s fortune peaked at $66.3 billion, according to Forbes estimates.
He was born into a poor rural family and spent his early career working as a steel technician and salesman for a property developer.
The entrepreneur founded Evergrande in 1996, which he expanded rapidly by borrowing significant amounts of money to build apartments, and repaying that debt once the properties were purchased.
The company has since become a symbol of the excesses fuelled by China’s property bubble with its lavish spending.
In addition to its core property business, Evergrande owned theme parks, purchased a soccer club (Guangzhou FC), and sold electric vehicles, while Mr Hui flew around in private jets.
But Mr Hui’s downfall began in 2020, when China’s government introduced new rules (known as “the three red lines”) to restrict the amount of cash that large real estate developers could borrow — as it was getting increasingly concerned about the level of debt linked to the nation’s real estate market.
This forced Mr Hui’s company and its debt-burdened competitors to sell their off-the-plan apartments at massive discounts in order to stay afloat.
Evergrande’s shares have plummeted by 99 per cent in the past five years, and are almost worthless at less than one cent apiece. Mr Hui’s fortune has since dwindled to about $5 billion.
Missing payments and liquidation proceedings
On top of its executives’ legal problems, Evergrande’s plans to restructure its debt have been dealt a significant blow, bringing it closer than ever to being completely wound up.
This would be unwelcome news for the hundreds of thousands of Chinese property buyers who have paid (in some cases) their life savings for off-the-plan apartments that Evergrande still has not finished building.
The company has been blocked from issuing new debt because China’s corporate regulator is investigating Evergande’s mainland unit (Hengda Real Estate) for alleged violations of requirements to disclose information to investors.
It is also locked in negotiations with foreign creditors to restructure more than $US30 billion worth of overdue debt, as it faces liquidation proceedings in the Hong Kong courts on October 30.
“I think there is very little appetite from the government to actually want to bail out these developers in full, especially with thousands of homeowners and investors still waiting for their apartments to be complete,” said Joseph Lai, chief investment officer at Ox Capital Management.
“But there is, of course, a desire to support the system, so it doesn’t lead to systematic problems.”
Potential impact on Australian trade and financial markets
In its financial stability review published on Friday, the RBA noted that the “direct links between mainland China’s financial system and advanced economy banking systems are limited”, but Australia would not be immune from the fallout.
“Widespread financial stress in China would therefore affect advanced economy financial systems mostly via its impact on Chinese trade and a general increase in risk aversion in global financial markets,” the RBA wrote.
Typically, when investors are feeling “risk averse”, it leads to heavy selling on share markets.
Last week, Australia’s benchmark stock index — the ASX 200 — fell to its lowest level in about 11 months, while the local currency briefly dipped below 63 US cents — well off its highs of 72 US cents earlier this year.
“The main effects of financial stress in China on Australia would likely be felt through slowing global economic activity, lower global commodity prices and reduced Chinese imports of Australian goods and services,” the RBA wrote.
“This is a result of connections between Australia and China being far stronger through trade rather than financial linkages.”
The Australian commodity that would be affected the most is iron ore — the steel-making ingredient China has been reliant on for its infrastructure-building stimulus measures.
Last year, Australia exported $184.7 billion worth of goods and services to China, according to Department of Foreign Affairs and Trade data.
Iron ore exports make up 56 per cent of that total, followed by natural gas at 10 per cent, and crude minerals at 6 per cent.
Australia’s property market could also be affected
China’s property downturn may also have unintended consequences for Australia’s housing market and housing affordability.
“I don’t think that you will have a systemic shock to this Chinese economy,” Ms Liu said.
“If anything, the Chinese housing market is stabilising or getting less bad, though it’s not recovering fast.”
With Australia experiencing its strongest population growth in decades, she expects more Chinese nationals to migrate here.
“So it’s actually good support for Australian property markets because, quite frankly, we just like places to live in major capital cities.”
Rabobank’s global strategist Michael Every had a similar view.
“If you can’t make any money on property in China, which you can’t, you’re going to get more and more Chinese investors looking around and thinking, ‘where can we still make 10 per cent a year for doing nothing?'” he said.
“And the answer is in Australian property, so you could have many, many more people coming down and making Sydney and Melbourne and other big cities even more unaffordable than they already are.”
That scenario could fuel further inflation, and risk making interest rates an increasingly complicated picture in the weeks and months ahead.
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