China’s tale of two cycles shows bad debt bogeyman lives

BEIJING - JULY 22: (CHINA OUT) A clerk counts stacks of Chinese yuan at a bank on July 22, 2005 in Beijing, China. The People's Bank of China, the central bank, announced on July 21 to scrap the yuan's decade-old peg to the U.S. dollar, and in stead phase in a flexible mechanism of the yuan exchange rates. The exchange rate of yuan vs U.S. dollar was announced at 8.11 vs 1 on July 22. (Photo by China Photos/Getty Images)


A business cycle upswing is giving the impression that China’s financial vulnerabilities are also on the mend. Yet the evidence in support of this cheery view is patchy at best.
Since financial booms and busts play out over a far longer horizon and have a bigger amplitude than more frequent waves in corporate sentiment, a dose of skepticism about runaway leverage in the People’s Republic is still warranted.
It’s easy to get taken in by GDP growth, which accelerated for a second straight quarter. Figures released Monday showed the economy grew 6.9% from a year earlier in the first quarter, better than the 6.8% expansion recorded in the three months to December.
The property market is undoubtedly playing a large role. Fixed-asset investment excluding rural areas swelled 9.2% in the first quarter, accelerating from 8.1% growth last year.
Chalk up that gain to the business cycle, however. Financial weaknesses in this leading sector of the economy still persist. A yield curve derived from prices of more than 100 US dollar-denominated bonds issued by Chinese developers shows investors demand a significant premium over Asian financial firms’ BBB-rated notes, across all maturities.
For the creditworthiness problem in Chinese real estate to abate, home buyers need to keep biting. As they take out more loans, builders’ cash flows get a boost. A 25% increase in bank advances to households in March shows they’re doing exactly that, with the benefit of their optimism flowing over to highly indebted developers like Guangzhou-based China Evergrande Group, which reported a 32% jump in contracted sales last month.
Evergrande’s shares are up 71% this year, though one of its new dollar bonds maturing in five years still pays 7.2%, compared with 4.7% for Chinese developers on average and more than double the 3.1% yield on a Bloomberg index of Asian financial companies’ notes.
Given authorities’ stop-and-go attitude to housing bubbles, it’s doubtful if the property mania will endure. Besides, with monetary conditions getting tighter in China, the business-cycle upsurge is starting to look exhausted even as banks’ corporate advances are showing only the slightest hint of improvement.
It will take a protracted business-cycle recovery to reduce what Bank of Communications Co. president Peng Chun characterizes as huge pressure on asset quality. Since that’s only possible with real-estate investment remaining strong, developers like Evergrande—Asia’s largest junk note issuer this year—will likely bet that authorities in Beijing will remain reluctant to stamp out demand for new homes with monetary overkill.
That may be a rational gamble, but it’s still all about keeping the business cycle going while expecting the financial cycle to lose its sting. Which could be hoping for a bit too much, a bit too soon.
— Bloomberg

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