Winners and losers from the end of China’s property bubble

China dream

As promised yesterday, the blog looks today at the potential Winners and Losers from President Xi Jinping’s ‘China Dream’.  It is a complete break from the policies of the previous leadership, which ended up being based on a ‘wealth effect’ created by an unsustainable property bubble.

Xi’s programme is emphatically about the longer term.  There will be 2 or 3 years of pain, as he resolves the issues connected with the ‘lost decade’ of the previous leadership. Then, if he is successful, many opportunities will open up for the future.  It therefore seems sensible to start with the Losers, as they will be many, and then look at the long-term Winners.

The Losers can be summarised as follows:

LOSERS – DIRECT
1.  Anyone dependent on Chinese demand for growth

  • Industries currently based on exports to China such as autos, metals, energy, chemicals, luxury goods
  • Countries based on exports to China including Latin American exporters, Asian exporters

2.  Anything for which Chinese lending has been critical

  • Official and shadow banking borrowers in China’s SOE and private sector
  • Real estate, and commodities financed by the ‘collateral trade’ in China

LOSERS – INDIRECT
1.  Service sectors supported indirectly by China’s growth and lending

  • Areas supported by the post-2008 stimulus impact on global trade flows eg shipping, finance
  • Investors in financial assets eg almost 50% of S&P 500 earnings come from outside the US

2.  Markets where Chinese buyers have become major players overnight since 2008

  • Real estate markets around the world eg London, New York, Singapore
  • M&A undertaken to boost China’s overseas asset base eg energy, trophy assets

At the same time, Xi’s dream opens up major new opportunities.  These will sustain new types of demand for future decades if he is successful, and create the potential for a wide range of companies to become Winners.

WINNERS
1.  Areas that will help China become a ‘moderately well-off society’ by 2020

  • Xi wants a Strong economy and government, where GDP/capita will double
  • He also want a Beautiful China where today’s toxic levels of land, air and water pollution have been remedied

2.  Modernising China so it becomes a fully developed nation around 2050 (the centenary of Communist rule)

  • He wants a Creative society where China re-establishes a leading position in science, technology, business etc
  • He aims to create a Bountiful China by raising urbanisation levels within 20 years to 75% from today’s 50%

CONCLUSION
There really seems to be no going back.  China’s property bubble is now collapsing with central Beijing prices falling 40% since December.

Investors and companies cannot afford to indulge in wishful thinking about what is happening in China.  Xi Jinping is indeed starting to act as his father’s son, just the blog suggested a year ago on his appointment.  Anyone who does not now change direction fast will soon find themselves left hopelessly behind.

But the indirect impact of the new policies on the rest of the world may in the end prove even greater.  The great tap of liquidity that was China’s post-2008 stimulus programme is now being turned off, slowly but surely.

As described yesterday, this is an earthquake which is set “to eliminate up to half of its industrial base“, as well as “costly building projects in cities that never find a niche and industrial facilities unable to compete in the world.”

It will almost certainly trigger massive earthquakes in other countries, as its impact moves along “the debt-fuelled ‘ring of fire” constructed by central banks” over the past few years.  Good assets will be as vulnerable as bad ones, as investors may have to sell whatever they can to pay down their debts.  And bad assets tend to become illiquid, so ‘safe assets’ will be hit temporarily people scramble for cash to avoid bankruptcy.

The important fact to remember, however, is that this will provide well-managed and far-sighted companies with the opportunity to develop major competitive advantage for the future whilst others struggle.

As the summary above shows, the government has made clear what they have to do to be Winners in the new world of Xi’s China Dream.  Those who ignore the message will likely end up instead as Losers.

 

President Xi Jinping’s ‘China Dream’

China dreamA new type of leader seem to be starting to emerge in China and India.  President Xi Jinping in China, and premier Narendra Modi in India, are not spending much time studying the output of focus groups or investment bank analysts.  Nor do they have ‘spin-doctors’ worrying about every phrase on the 24-hour news channels.

Instead, they have ideas about what they want to do, and clear implementation plans to achieve them.

It is easy, of course, to be cynical about their ambitions.  But let us suppose for a moment that:

  • They really do want to use their power for a purpose, as leaders such as Gandhi did in the past
  • They are serious about tackling the key issues – and the pervasive corruption that stops reform taking place

Companies and investors need to study this potential scenario very seriously, as it is a long way from the current ‘business as usual’ model.

We can see this by trying to understand what they might want to achieve with their power.  Today and tomorrow, the blog looks at Xi Jinping, and next week it will look at Narendra Modi.

Author Robert Lawrence Kuhn has helpfully spelt out Xi Jinping’s China Dream, which the blog has highlighted in the chart above.  Kuhn has long been a strategic advisor on China, and his summary has been endorsed by Xi himself.

In Xi’s dream there is nothing about creating a wealth effect via further stimulus of the property bubble.  This was a policy of the ‘lost decade’ under the previous regime.  It allowed corruption to flourish, as it was easy for officials to profit personally from land seizures, whilst building ‘ghost cities’ to meet their GDP targets and local tax income needs.

Xi’s position was made clear 3 months ago, when Cement Shen’s property business went bankrupt in Fenghua.  It is well worth re-reading the policy statement in state-owned China Daily at that time, which set out very clearly what would, and would not, be part of the government’s programme for the next few years.

The headline itself highlights the overall direction: ‘No pain, No gain, for China reformers’. 

“A thorough cure means it could take a long time for the patient to feel better. Judging from the immense task China faces, it’s going to be another two years, at least, before change can be quantified in the central government’s statistical reports.  Some assets, valuable just a few years ago, will become useless. The money that was spent on them, and their contribution to GDP, likewise will vanish.  Those assets will include costly building projects in cities that never find a niche and industrial facilities unable to compete in the world.” 

THE GOVERNMENT ROLE
Xi’s dream therefore has very practical elements, focused on the role of government:

  • It requires a Civilised society with equal opportunity and one law for all
  • In addition, it needs Stable government, with consistent policies
  • And it requires a Harmonious society with goodwill between different ethnic groups and classes

Will this be easy to achieve?  Of course not.  Will there be major challenges along the way?  Of course there will.  The China Daily article sets out several of the major ones,  such as:

“If, as some business commentators propose, the country is to eliminate up to half of its industrial base to make way for business based on the mobile Internet, it will have to keep the credit line really tight for local development projects.”

The key point is that Xi and premier Li have 4 years before the leadership is due to be reappointed for its second 5-year term in March 2018.   And thus it makes total sense for them to tackle the key issues now, over the next 2 years, so that by 2017/18 they can point to signs of progress

Tomorrow, the blog will look at the likely Winners and Losers from the end of China’s current growth model, as the property bubble is burst.