Fear is in the air as China’s problems get even worse

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When China’s authorities resort to a measure last used in 2008, in the midst of the global financial crisis, you know that anxiety is increasing in Beijing.

Last weekend the authorities halved the stamp duty on share trades, lowered margin deposit requirements for leveraged trades, imposed restrictions on share sales by major shareholders, said they would slow the volume of initial public offerings and instructed some large mutual funds to avoid net selling of equities.

Pressure is building on Chinese President Xi Jinping to make a decisive move to help shore up the economy.Credit: AP

The measures, the Ministry of Finance said, were designed to “invigorate capital markets and boost investor confidence.”

When China last cut the stamp duty on share trades during the GFC, the Shanghai Composite index jumped more than 9 per cent in what became a sustained rally.

On Monday, the CSI300 initially bounced 5.5 per cent but ended the day up only 1.17 per cent. The index had fallen about 7 per cent this month and is nearly 11 per cent off its year-high, reached in January.

The authorities clearly want to put a floor under their equity markets and, by tightening liquidity by discouraging sales and new issues, amplify the impact of any buying to offset the impact of an exodus of foreign investors this month. There have been near-record levels of outflows of foreign funds from the market in recent weeks.

The obvious concern being shown about the state of the market probably relates to both the wealth and psychological effects of a slump in equity prices.

The People’s Bank of China has also been doing what it can to prop up the value of the yuan, setting stronger than expected daily fixes and tightening liquidity in offshore markets to deter short-selling after the currency hit a 16-year low against the US dollar earlier this month.

The loss of confidence in China’s economic condition and outlook can also be seen in the performance of the Australian dollar – often seen by foreign investors and traders as a safe way of getting an exposure to China – over the past fortnight. It has crashed from just under US69 cents to just over US64 cents.

The Chinese authorities are battling against a tide of negativity, and not just from offshore.

China’s benchmark sharemarket is down sharply on the year.Credit: Bloomberg

The collapse of the country’s property market has left China’s households, for whom property has been a primary store of wealth, burned and indebted and the property development sector on life support.

In 2008, part of the explanation for the big rebound in China’s sharemarket was the massive wave of stimulus Beijing injected into its economy, stimulus focused on infrastructure and property development.

The over-investment in both sectors in the decade and a half since the financial crisis and the distressed state of the property market means new investment on a meaningful scale isn’t an option.

For the moment, the authorities are trying to help developers complete the vast inventory of uncompleted developments, more to protect home buyers who have taken out mortgages to buy apartments under the pre-sales model the developers used to fund their projects than to bail out the developers.

With China Evergrande deferring a vote that was scheduled for Monday on its offshore debt restructuring plan – apparently because it didn’t have the votes – and Country Garden, which has four times as many incomplete projects as Evergrande, also shifting the deadline for bondholders to vote on a three-year extension of the repayment date for a $US535 billion ($831 billion) note issue, there is no stability or end in sight for the sector’s distress.

The sector will weigh on China’s growth and its citizens’ confidence for years if what are effectively zombie companies continue to be propped up by drip-feed funding from state-owned banks and, even if the developments are completed, China will end up with a massive stock of excess housing capacity even as its population is shrinking.

Consumption is weak, exports and imports have been falling, its factories have increasing levels of idle capacity, foreign direct investment has been tumbling and youth unemployment has been so extreme (21.3 per cent on the last available figures) that the authorities have decided to stop publishing the numbers.

In most economies, the collapse in external trade and the outflows of foreign capital would probably lead to an attempt to drive up consumption-driven growth via direct transfers of cash to households.

The collapse of the country’s property market has left China’s households, for whom property has been a primary store of wealth, burned and indebted and the property development sector on life support.Credit: Getty Images

That hasn’t happened in China and all the indications so far have been that it won’t happen. That may be because the authorities believe households would, in the current environment, probably save rather than spend any handouts.

It might also be because Xi Jinping is said to regard that option as wasteful when Beijing’s financial capacity could be used to further his strategic objectives by boosting the state-owned enterprises aligned with his ambition of dominating a number of 21st-century technologies and strengthening China’s military capabilities.

With China’s economic growth spluttering and the economy experiencing deflation, the attempt to stabilise the sharemarket and currency, the interest rate cuts, incentives to buy electric vehicles, whitegoods, electrical appliances and even furniture represent a piecemeal approach to a deepening problem that has structural implications.

Property development once contributed more than 30 per cent of China’s growth and has been a major source of local government revenues. It’s also been a major factor in the indebtedness of the developers, households and local governments.

The collapse of the country’s property market has left China’s households, for whom property has been a primary store of wealth, burned and indebted and the property development sector on life support.

Those local governments and their off-balance sheet financing vehicles are highly leveraged but have lost the revenue from land sales that once accounted for as much as half their income.

They need to be restructured and recapitalised but, again, there are no signs of a serious attempt to reform their finances, with Beijing dispatching teams of bureaucrats to the provinces to provide advice/directions rather than providing new funding.

There have been reports that the authorities might encourage the local governments to extend the terms of their borrowings significantly to ease the pressure but that would be a deferral of the problem, not a solution.

Xi, whose policies on developers’ leverage and crackdown on the big private tech companies precipitated the collapse of the property sector and risk-aversion in the private sector, diagnosed the structural challenges an overly-indebted China faces correctly but implemented the responses crudely.

While the economy is still growing and might hit its targeted growth rate of 5 per cent this year if the advanced economies don’t slip into recession, China’s internal imbalances and challenges and the rush by the US and other Western economies to restructure their supply chains away from over-dependence on China and protect their strategic technologies mean there will be growing pressure on Xi to do something more decisive to avoid a continuing decline in growth and in the capacity of the economy to fund his geopolitical ambitions.

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