Chi on China Playing Devil s Advocate with China s Property Market

Transcription

1 For professional investors 31 July Chi on China Playing Devil s Advocate with China s Property Market SUMMARY We have argued recently 1 that a property market correction was the biggest policy challenge for Beijing. But the immature nature of the Chinese financial system suggests that a US-style price collapse would be unlikely. Direct risks to the household and banking sectors would be manageable. Transaction volume will likely bear the brunt of the correction, leading to a chain effect on the economy and bank balance sheets that cannot be accurately assessed. Due to this uncertainty, Beijing is moving to avoid a market meltdown through selective policy easing. We play devil s advocate here and ask what if Beijing does not come to the rescue? Our assessment shows that GDP growth could fall below 7% and the banking system s Tier 1 capital could be wiped out. This supports Beijing s determination to prevent a property Armageddon. Beijing has so far refrained from massive economic bailout, despite the risk of a property market correction pulling the rug from under the economy. Policy hawks argue that Beijing should not come to the market s rescue. Allowing a thorough adjustment in the property market and related industries alongside financial liberalisation should be part of structural reform, but a drastic change can be dangerous in the short-term. The risk of a property collapse wreaking havoc on the economy is not negligible, leaving Beijing determined to keep any property woes from getting out of hand and maintain a selective easing policy bias until the dust has settled. 1 Chi on China: China s Property Bubble (Part 1 of 3): What Bubble? 3 June 2014; Chi on China: China s Property Bubble (Part 2 of 3): What Risk? ; 11 June 2014; Chi on China: China s Property Bubble (Part 3 of 3): What Impact? 2 July 2014.

2 Playing devil s advocate with China s property market 31 July What if Beijing stands pat? How much pain will the property market correction inflict on the system? We look at this issue from two angles: GDP growth and banking sector risk. Note that these assessments can only give a rough idea of the possible outcomes but not a concrete conclusion due to the lack of reliable data. Impact on GDP growth The key concern is not property price collapse but transaction volume contraction 2. Total property investment accounts for 15% of GDP, with housing alone accounting for 10%. If related sectors, such as materials, cement, steel etc., are added, total property investment accounts for more than 20% of GDP. Property has a pervasive impact on the economy via its links with: The heavy and downstream industrial sectors Local government revenues (50% of local fiscal revenues come from land sales) and spending (90% of local government investment are in property and related areas) Collateral for bank lending (about 45% of bank loans are collateralised by property) Personal wealth (20%-30% of wealth management and trust products are linked to property). Table 1: Impact of property investment growth on GDP growth (ceteris paribus ) Property investment growth 2013 actual 19.8% 19.8% A scenario 1 scenario forecast 14.8% 9.8% B Expected change in property investment growth -5.0 ppt ppt C Market estimates of property inv't as % of GDP 16.0% 25.0% D Impact on GDP growth (C*D) -0.8 ppt -2.5 ppt E GDP growth 2013 actual 7.7% 7.7% F 2014 GDP growth forecast (E+F) 6.9% 5.2% sources: CEIC, BNPP IP (Asia) 2 See Chi on China: China s Property Bubble (Part 2 of 3): What Risk?, 11 June 2014.

3 Playing devil s advocate with China s property market 31 July Table 1 presents a benign (1) and a risky scenario (2). The market s forecast for property investment in 2014 ranges from 14.8% in scenario 1 to 9.8% in risky scenario 2 (i.e. a 5 and 10 percentage point contraction, respectively). Its estimates for property investment as a percentage of GDP range from 16% to 25%. Under scenario 1, where property investment accounts for 16% of GDP, a 5 percentage point fall in investment growth would subtract 0.8 percentage points from 2014 s GDP growth (5 x 16%), while under scenario 2, where property investment accounts for 25% of GDP, a 10 percentage point fall in investment growth would subtract 2.5 percentage points from growth (10 x 25%). In other words, if there is no policy easing to offset the contraction in property investment, GDP growth could fall below 7.0% this year, a level that is believed to be below Beijing s tolerance limit. So the government has a strong incentive to prevent property investment from collapsing. Impact on the banking system As of 1Q 2014, China s banking system had an average Tier 1 capital of RMB8.1 trillion, or 10.9% of riskweighted assets. Table 2 breaks down the banks exposure to the property sector. Direct exposure via mortgage and developers loans was RMB15.2 trillion. The market s estimate for banks on-balance-sheet property investment ranges from RMB2.7 trillion in scenario 1 to RMB5.4 trillion in scenario 2. Indirect exposure, via trust and entrusted loans and wealth management products, is estimated at between RMB3.8 trillion and RMB7.3 trillion. According to listed banks data, half the loans are collateralised, with 90% of those by property. This means 45% of bank loans are collateralised by property (item D in table 2), with estimates ranging from RMB10.4 trillion to RMB15.2 trillion. There is also exposure via local government debt (LGD), 72.5% of this is funded by banks, according to our estimate 3, amounting to RMB13 trillion. Total bank exposure to the property sector is estimated at RMB45.1 trillion under scenario 1 and RMB56.1 trillion under scenario 2. Meanwhile, we estimate conservatively that non-performing loans (NPLs) amounted to 37.6% of total loans 4, or RMB17.0 trillion and RMB21.1 trillion under scenarios 1 and 2, respectively. According to the government, the bad debt recovery rate has remained at 25% in recent years. But NPL provisions amounted only RMB1.8 trillion in 1Q So theoretically, banks could lose between RMB11 trillion and RMB14.1 trillion. Given that Tier 1 capital was only RMB8.1 trillion, a sharp property market correction causing NPLs to soar (towards our conservative assumption, for example) would more than wipe out all Tier 1 capital. 3 The government s official NPL was 1.04% of assets in 1Q See also Chi on China: China s Systemic Risk (II/II): Local Government Debt, 14 May See Chi on China: China s Systemic Risk (II/II): Local Government Debt, 14 May 2014.

4 Playing devil s advocate with China s property market 31 July Table 2: Impact of property sector on banks (ceteris paribus ) T Tier 1 capital (1Q 14) 8.1 RMB trillion Risk-weighted assets (1Q 14) 73.8 RMB trillion Tier 1 capital ratio (1Q 14) 10.9% RMB trillion, except noted (1Q14) scenario 1 scenario 2 Remarks A Direct (on-balance-sheet) exposure Mortgage Loans to developers B Direct (on-balance-sheet) property investment %-20% of total bank investment C Indirect (off-balance-sheet) exposure Trust loans to developers Entrusted loans to developers Property-related WMPs D Other indirect exposure E Exposure via local government debt % of loans are collateralised, of which 90% are backed by property 72.5% of the RMB17.9 trillion LGD is funded by banks F Total exposure (A+B+C+D+E) Non-performing loans (NPL) 37.6% 37.6% based on our conservative assumption G => NPL = F*E H Est. loss to banks (assuming 25% recovery rate) = G* I NPL provisions J Est. net loss to banks (H-I) New Tier 1 capital (T-J) Tier 1 capital more than wiped out! sources: CEIC, listed banks, market estimates, BNPP IP (Asia) This is not to say the banking system would crash. A closed capital account and Beijing s selective implicit guarantee would prevent a systemic shock. But the potential impact on the banking system means Beijing cannot afford not to intervene; it will have to ease policy further to avert a property market collapse. Chi Lo Senior Economist, BNPP IP

5 Playing devil s advocate with China s property market 31 July DISCLAIMER This material has been prepared by BNP Paribas Asset Management S.A.S. ( BNPP AM )*, a member of BNP Paribas Investment Partners (BNPP IP)** and is made available in Australia by BNP Paribas Investment Partners (Australia) Limited ABN , AFSL , ( BNPP IP ). It is produced for general information only and does not constitute financial product advice. You should consider obtaining independent advice before making any investment decision in relation to any financial product referred to. The value of investments can go up and down. Past performance is not necessarily indicative of future performance. Any opinions included in this document constitute the judgment of the document s author at the time specified and are subject to change without notice. Given economic, market and other risks, there is no guarantee that any investment strategy referred to in this document will achieve its objectives. The contents of this document are based upon sources of information believed to be reliable, but no warranty or declaration, either explicit or implicit, is given as to their accuracy or completeness. BNPP IP to the extent permitted by law, disclaims all responsibility and liability for any omission, error, or inaccuracy in the information or any action taken in reliance on the information and also for any inaccuracy in the information contained in the document which has been provided by or sourced from third parties. *BNPP AM is an investment manager registered with the Autorité des marchés financiers in France under number 96-02, a simplified joint stock company with a capital of 64,931,168 euros with its registered office at 1, boulevard Haussmann Paris, France, RCS Paris ** BNP Paribas Investment Partners is the global brand name of the BNP Paribas group s asset management services.