China Economic Review

The three weaknesses

Our prediction has always been that the Chinese economy is solid, until the day when suddenly it’s not. What could shift the status quo? The three most likely factors are property, debt and trade war, and on all three fronts we saw developments this week.

First, property. A survey by the FT’s Confidential Research suggested that a significant proportion of real estate investors – more than 20 percent – would sell if a property tax was instituted. How important is a property tax in terms of stabilizing local government finances, resolving their indebtedness and weaning them off property speculation? Who knows, but it’s definitely not insignificant. The latest NPC session in March floated the idea again after unsuccessful attempts to introduce such a tax in Shanghai and Chongqing in years gone by. The latest survey is not encouraging.

By unsuccessful, we don’t mean that Those in Command could not do it. Of course they can. But we can only assume that the plan was dropped because of a real potential for a dramatic fall in valuations. The suggestion in March was that the tax would be introduced in a gentle, thin-wedge way, but Chinese real estate investors know a trend when they see it. Allowing Chinese people freehold ownership rights would solve the problem, of course. Haha.

Second, debt. A Chinese manufacturing group in Zhejiang, DunAn, appealed for a government bailout to help manage its $7 billion in outstanding loans, according to the Financial Times. The company apparently blamed Beijing’s deleveraging drive for its “extremely serious liquidity difficulties.”

How many other companies across China are in a similar situation? And how long can Beijing bail out such entities to forestall domino reactions? Meanwhile, Chinese credit spreads widened this week to a two-year high as the threat of local government debt defaults weighs on investors.

Some of China’s biggest borrowers are local government financing vehicles (LGFVs) that allow non-federal government bodies to take on additional credit for local infrastructure projects. No LGFV has yet defaulted on a publicly traded bond. Yet.

And third, trade war. ZTE announced that the penalties imposed on it by the United States because it did sanction-busting deals with Iran will mean the whole company has to close. This indicates with blinding clarity how significant the US remains in the world economy. It is a part of the answer to one question we asked last week: who needs whom more? What are the consequences for China’s economy of the ZTE bombshell, especially if the US takes the same steps against other Chinese companies that traded in contravention of sanction rules?

Lots of other questions, no answers. Enjoy the weekend weather.