Current issues in the field of economics, (responsible) investment, pensions and income: every week an APG expert gives a clear answer to the question of the week. This time: chief economist Thijs Knaap on whether the global economy will be hit by the sky-high debt of Chinese property developers. “The chance that all hell will really break loose and Chinese citizens will lose faith in the government’s ability to solve this crisis is small.”
Will the embattled Chinese real estate market cause a global crisis in financial markets, like what happened with the collapse of Lehman Brothers in 2008? That is the question that has been occupying the minds of many investors since it became known that Chinese real estate giant Evergrande (total debt €260 billion) could no longer meet its interest payment obligations. According to Knaap, this is unlikely. “The first question is whether this real estate crisis is a threat to the Chinese economy itself. You can never know that 100 percent for sure, but there is only a small chance of that. This is because the Chinese government is in a much stronger position to intervene than Western governments, partly because it owns portions of the financial sector. If the government wants a company to get a loan from the state bank, then the company will get the loan. This way it can bail out companies when it wants to.”
Moreover, the Chinese have a lot of debt but mostly to themselves, says Knaap. That too contributes to the government’s ability to manage the economic risk. “There is no need to be afraid that foreign creditors will be on the doorstep, wanting their money back immediately.”
A financial domino effect like the one caused by the fall of Lehman Brothers is therefore not likely, according to Knaap. “The risk of a crisis in a particular sector spreading to the entire economy is much smaller in China than it is for us, due to that dominant government role. People are not afraid to let things blow over. There are some examples of where this has gone well, such as Baoshang bank and Huarong asset management. Also, don’t forget that the Chinese government itself actually triggered this crisis. For that reason alone, it is a very different situation than with Lehman. At that time, it was not the government that provided the trigger, but the housing market.”
Taking on pain
In what sense did the Chinese government evoke this crisis? Knaap: “Chinese real estate developers are borrowing heavily and robustly. Those in power are now having some reservations about this. Because if debts continue to rise, the financial risk will simply become too great. To put a stop to this, the regulator introduced a number of rules last year. Because of these new, stricter rules, real estate companies with a lot of debt were no longer able to borrow money in the way they were used to. As a result, they had to rely on selling their own properties. In the end, that didn’t happen fast enough, so the debt-based growth model came to a halt. That’s painful. China has chosen to take on the pain while the problem is probably still local and manageable. And we should actually be happy about that. Because if things go well, this intervention will prevent companies’ debt position from really becoming a systemic risk.”
And that also keeps the risk to the global economy manageable, Knaap explains. “As long as the Chinese don’t panic, it won’t damage their economy and the problems in the real estate sector will probably be manageable. There is no crisis of confidence as with Lehman, in which there was a fundamental uncertainty in the financial markets. Globally, the economic impact is therefore limited to foreign creditors of Evergrande who are unlikely to get their money back. The likelihood for all hell to break loose and Chinese citizens losing confidence in the government to solve this crisis is small. But if that does happen, we will also notice it here, in the form of fewer exports and problems with product supply.”
However, according to the economist, we should take into account the effect of the stricter credit requirements on the debt accumulation of the Chinese. “The more borrowing is going on in China, the more we will notice this globally in an economically positive sense. Until now, China has always dealt with economic headwinds by taking on more debt and thereby investing in the growth of the economy. But the limit of that method has now been reached. Chinese people are less likely to get mortgages and some companies are no longer granted credit. This is at the expense of economic growth, and so people abroad are going to notice. That is the main effect and it will likely be felt globally."