Is China particularly vulnerable to a real estate shock?
Real estate accounts around 25% of GDP and 80% of household wealth. It is also a big source of government revenue. Debt-fuelled real estate growth is one reason China’s credit to GDP ratio is 300%-plus.
But does Beijing have the means to contain Evergrande crisis?
Yes. Evergrande debt is less than 2% of Chinese GDP and less than 0.7% of total Chinese credit. China’s financial system is largely state controlled and provides ample absorption capacity. Its massive foreign exchange reserves (which were utilised earlier to resolve banking NPAs) provide additional cushion.
So will the government step in to smooth things over for Evergrande?
The answer depends on whether China wants to clean up the property sector or postpone the problem. Our bet is that China will want to clean up real estate. Beijing’s response will try to address property buyers’ frustrations, ensuring there’s no financial contagion and cleaning up excess debt in real estate. It is unlikely that China will let a global financial contagion emerge immediately after a pandemic.
So, what’s the upshot for China and the world?
Globally, a financial contagion is unlikely. But the near-term fallout on China’s growth and, therefore partially on global growth, can be significant. China’s property sector has strong forward and backward linkages and employs a large number of people. A drop in property prices will hurt big ticket purchases such as autos and consumer durables.
And this will have an effect on global growth as well. Today, China’s share in global GDP is 19% (PPP terms). China’s share of capital expenditure is an incredible 30% of global capex. Plus, a slowdown in its construction sector will likely have knock-on effects on global commodities and any retrenchment by China’s households will affect global auto and luxury goods sales.
Are there other compounding factors?
What complicates the global growth challenge further is that fiscal support is beginning to wane in the rich world. US fiscal transfers to the households are ending in September and pent-up demand in US and Europe is subsiding. China’s real estate correction will happen at a time the global economy is yet to broaden/transition from nominal recovery to real recovery; that is, most emerging economies, and small businesses and low income households everywhere in the world haven’t recovered.
Is India going to be negatively affected?
Not necessarily a whole lot. First, India’s economic recovery has been V-shaped, although there are some concerns about MSMEs and employment. Exports, including agriculture exports, are on course to exceed $500 billion for the first time. Large companies have benefitted from easy liquidity, low interest rates and market share gains from smaller players. Real estate activity too has perked up especially in the organised segment. If RBI keeps maintaining the easy liquidity stance for some more time, and GoI ploughs back higher tax revenues back into the economy through spending in the coming quarters, India may largely escape.
There’s an opportunity here for India
The Evergrande crisis presents another chance for India to capitalise on China+1 theme. With the PLI scheme India has made a good beginning. However, we have to create many examples like Samsung, which has shifted their entire mobile handset manufacturing from China to India. China’s crackdown on their tech companies has also created jitters among global investors.
The likely inclusion of India’s sovereign bonds in the global bond index and potential rating upgrades are good omens. Improving further on the ease of doing business and ease of making investment can make India manufacturer to the world, just as it became the back office and generic pharmacy to the world.
The writers are, respectively, Managing Director and Senior Fund Manager, Kotak Mahindra Asset Management