There are concerns that a disorderly collapse could trigger a wave of events that would spread stress to other parts of the financial system and economy. It is perhaps no wonder that market noise has risen to ear-splitting levels.
While there are risks worth watching and listening out for, here are four reasons why the noise around Evergrande needs to be dialled down and placed in context.
That said, while there are risks worth watching and listening out for, here are four reasons why the noise around Evergrande needs to be dialled down and placed in context:
- Some metrics of housing vulnerability are potentially concerning, but not all are flashing red. Aggregate house prices may have risen by some 40% since 2015, but over the same period, average incomes have slightly outpaced these gains. Household debt is also not particularly high by international standards. Household debt has, however, grown very quickly – up by 35 percentage points of gross domestic product (GDP) since 2010. This implies that debt is increasingly being used to bridge an affordability gap for recent buyers. While China’s recourse mortgages and large down payments may help banks rest easy, in a downturn, they could still cause more than a few sleepless nights for households who recently got on the property ladder.
- Urbanisation has been a key driver of demand and will continue to be so. China’s urbanisation rate has risen by around 24 percentage points since 2000, but could remain a driver of housing demand for some time to come. Urbanisation (at some 60%) is roughly where you’d expect it to be given China’s stage of development; it is still well below the 80% average for wealthy Organisation for Economic Co-Operation and Development (OECD) countries. What’s more, some 180 million workers are still working in primary sectors, such as farming and mining. As the economy evolves, these workers will move into manufacturing and services. Demand for urban housing will likely follow.
- China’s stage of development suggests that demand and high house prices could persist. A lack of alternative savings vehicles, China’s relatively closed capital account, intergenerational transfers of wealth amplified by the ‘one child’ policy and still-rapid income growth are reasons to believe that high prices could potentially be sustained. In the case of Japan’s famous housing bubble, it had already reached advanced-economy status by the mid-1980s. China still has a long way to go before income per capita is comparable.
- Evergrande’s problems were triggered by government efforts to reduce risks within the industry. While there are risks in implementing measures to cut leverage in the property sector, government intervention, if executed well, should reduce risks further down the road. While the central government may let Evergrande default as a ‘lesson’, it is quite another thing to allow a disorderly collapse. The authorities still have considerable financial resources at their disposal to manage a controlled asset recovery process and therefore prevent contagion.
The outlook for property may remain tough. President Xi Jinping’s mantra that ‘housing is for living, not speculating’ isn’t new, but the increased focus on ‘common prosperity’ (amid more general moves to reduce social strains) suggests Beijing will be wary of leaning too heavily on real estate as a tool to support growth.
On the other hand, ample housing supply would help improve affordability – a relatively visible yardstick of social equality and/or inequality. This suggests that, to us, real estate should remain an engine of growth for China, albeit one that’s not as powerful going forward.
Company selected for illustrative purposes only to demonstrate the investment management style described herein and not as an investment recommendation or indication of future performance.