China: The Other International Risk

Posted by Brad McMillan, CFA, CAIA, MAI

This entry was posted on Apr 21, 2015 1:04:00 PM

and tagged Commentary

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ChinaAfter yesterday’s discussion of the Greek crisis, I thought we should take a look at the other major international risk: China. I haven’t written a lot about China recently, as there hasn’t been much news, but some recent developments warrant an update.

Troubling economic data

One of the problems with economics in general is that the data you need is late, obscure, and subject to multiple interpretations. In less developed countries the problem is worse, due to lack of data collection. And in authoritarian countries it’s worse yet, as there are enormous incentives for managers to fake it until they make it.

China’s statistics have long been suspect; even Li Keqiang, the current head of government, has called them man made and unreliable. Nonetheless, if Chinese statistics are unreliable, they’ve at least been consistently unreliable, which is why recent data is so unsettling.

  • At 7 percent, Chinese growth for the first quarter of this year is the worst since the first quarter of 2009, during the financial crisis, and the second lowest since 2001, according to Ned Davis Research.
  • The trend is worsening, with March posting the lowest numbers for the quarter.
  • Plus, given the Chinese government’s 7-percent target for growth this year, the actual number may well have been worse but adjusted upward to reflect that goal.

Growth this low is a potential sign of trouble.

Real estate worries

Actions by the Chinese government suggest it’s taking the slowdown very seriously. Over the weekend, the People’s Bank of China loosened banking reserve requirements in an attempt to spur lending, and there has been talk of a much larger direct stimulus program.

The problem is that, in recent years, increased bank lending and infrastructure spending have generated much less growth than in the past. With debt already at very high levels, and infrastructure and real estate arguably significantly overbuilt, the government’s ability to use those tools may be limited.

One sign that this may be the case is the recent large default by a Chinese developer on its overseas debt. Per today’s New York Times, the Kaisa Group announced on Monday that it had missed two large payments on U.S. dollar-denominated bonds, making it the first major Chinese developer to default on international debt.

Although there are special features to the Kaisa situation, real estate is considered a potential cause of a wider crisis in China, just as it was in the U.S. Henry Paulson, former U.S. Treasury Secretary, has noted that it’s not a question of if but when China will face a financial reckoning, and that the trigger could be a collapse in the real estate market.

Is a crisis brewing?

A crisis is not guaranteed by any means. China is attempting to rebalance its economy, reducing the risks, and the government has massive resources available to solve any financial crisis that emerges. Nonetheless, slowing growth and a large default in the very sector that could spark a crisis suggest that risks are rising.

While the rest of the world is—appropriately—focused on Greece, we should also keep an eye on China. As large as it is, even a contained adjustment would have consequences for everyone.

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