This is a re-post of an article originally published on pundit.co.nz. It is here with permission.
The recent financial failures of two ginormous Chinese property companies, Evergrande and Country Garden, at various times ranked the second largest and sixth largest in China, have implications for the New Zealand economy.
The Evergrande Group has been struggling since 2021 (here). It has just filed in a New York for Chapter 15, a bankruptcy protection in the US enabling it to restructure its debts. The debts – most are not American – are estimated to amount to an eye-watering US$300b (say NZ$500b). One assessment concluded that in February 2022 its liquidation would return only between 0% and 10% of principal to creditors.
Also in August 2023, Country Garden defaulted on the US$45 million with regard to interest disbursements linked to two offshore US dollar bonds. I won’t go through all the turmoil which has since happened, but summarise by saying that today Country Garden appears to be where Evergrande was two years ago. It may go down faster because Evergrande has undermined financial market confidence.
Moreover, while not so prominently in the news, there are many Chinese property companies – some comparably large – which are also in increasingly difficult financial troubles. China has many ‘shadow’ banks, that is banks whicch are not legally regulated in the usual way and which have the potential to collapse the entire financial system.
The immediate precipitant was that in August 2020, the Chinese government enacted a ‘three red lines’ rule which regulated the leverage taken on by property developers by limiting their borrowing based on the following metrics: debt-to-cash, debt-to-equity, and debt-to-assets. The rule’s purpose was to rein in the highly indebted property development sector. It has, but at the cost of undermining many of them. By October 2021, 14 of China's 30 biggest developers had violated the regulations at least once.
More fundamentally, there had been a speculative property boom starting over a decade earlier in which the companies relied on inflating property prices to ‘balance’ their books. It was a kind of Ponzi financing, compounded by local authorities financing themselves by selling land to the companies, who financed the sale from the cash flow coming from new investors and banks.
Because of the local authority involvement the companies have been building accommodation in third and fourth level cities, where there is no significant demand. There are pictures of rows of apartment blocks which are said to be entirely empty. They will be in the company books at cost plus inflation, but there is little prospect that they can be sold at those prices, if they can be sold at all.
Observe too that a rapidly growing company – anywhere in the world – is unlikely to develop rigorous internal systems to administer and monitor itself. It is not until the receivers move in that we learn just how slack the failing company has been (and how much corruption).
I take it that the central authorities judged that the boom was unsustainable, and that the later the crash the bigger it would be. So they thought it better to act soon, even if that put China’s property and financial markets into turmoil.
There is much more that can be pieced together or guessed. But the issue for this column is the impact on New Zealand and the world.
There is a general agreement that the financial instability may politically weaken Chinese premier Xi Jiang. At the very least, it requires him to pay more attention to domestic issues. Among the issues which would surely worry Xi and the central committee is demonstrations outside Evergrande’s offices by investors who had partly prepaid for housing which has not been built or finished and by subcontractors who had not been paid. The demonstrators may turn on the government.
This does not mean that China will cease to be significant politically in the international system. It is too big and important for that. There is even the uncomfortable possibility that it will be more aggressive externally in order to take its population’s concern off failing domestic issues. (Putin’s Russia is a current example, but history records many others.)
Moreover, the property sector is said to contribute 24-30 percent of China’s GDP. The turmoil in its property market seems to be contributing to the slowdown in the growth of the Chinese economy, which gives Xi less room for economic manouevre; it may slow down its commitment to the Belt and Road Initiative.
(The other great Chinese growth driver has been exporting and that too is hiccupping, partly because the world economy is slowing down and partly because many countries are trying to de-risk their dependence on China. It is also possible that the gains from its thriving export sector are not increasing as fast as they have done over the last few decades.)
One assumes that eventually the government in Beijing will bail out the Chinese property sector (and the local authorities and the banks that have been financing it). There are various ways of comparing the size of the Chinese and New Zealand economies; one says it is about 70 times as big. So Evergrande’s NZ$500b debt is equivalent to about $7b here. (Double it for the other property companies also going under?) Our Treasury and Reserve Bank would blanch at a bailout of this magnitude. (I have more confidence in their expertise to do a bailout; they have had more practice. And they wouldn’t have to deal with a shadow banking system.)
Will the financial turmoil in China impact greatly on the world financial system? The conventional wisdom is that the exposure is not great. There may be some non-Chinese financial institutions which are overexposed and will suffer – even crash – but presumably they are a small proportion of the total.
Of greater concern to New Zealand is whether the slow growth of the Chinese economy will impact on our exports there. Our trade dependence on China is extraordinary. It is the biggest market for milk products, sheepmeats (for beef it is only second), fish, apples, wine and honey (for kiwifruit it is third). Thirty years ago, China did not make New Zealand's top ten export destinations in any of these products. We may already be seeing an impact from the growth slowdown in international dairy product prices.
We have long been aware of our export overdependence on China, compounded by selling to other markets in East and Southeast Asia (including Australia) which are themselves very dependent on the Chinese economy. (Exports to these markets are about two-thirds of our total; China alone is a third.)
There have been considerable efforts to diversify; we have just settled free trade agreements with Britain and the EU. The big diversification could be with India, but the Indians have not been nearly as enthusiastic as we are. After all, compared to the others they are negotiating with we are a tiddler. A deal was a ‘priority’ for the Key-English Government, it has been for the Ardern-Hipkins one, and National has announced that it would be for them. There is a bit of a pattern here, isn’t there? When we finally get an FTA, it is likely there will be little improvement for dairy access.
We are negotiating trade deals which will add to the diversification: with the ‘Pacific Alliance’ – the Latin American regional group made up of Chile, Colombia, Mexico and Peru – and with the Gulf states – Saudi Arabia, United Arab Emirates, Qatar, Kuwait, Oman and Bahrain. Negotiations with the Russia-Belarus-Kazakhstan Customs Union are currently suspended, while a long-term ambition for an FTA with the US is hardly on the table. Open plurilateral deals enable new members to join, as when Britian joined the CPTPP, adding to the diversification; existing bilateral trade deals are also being upgraded.
This probably means that China and its associated economies will continue to dominate the prospects for the New Zealand economy for some time to come. What is going on in China’s property and finance markets may be more important to us than the October 2023 election.
*Brian Easton, an independent scholar, is an economist, social statistician, public policy analyst and historian. He was the Listener economic columnist from 1978 to 2014. This is a re-post of an article originally published on pundit.co.nz. It is here with permission.