Coal, Cement and Steel… Oh My!
Tara Joseph says, “Vincent, thanks very much for being with me. As we all know at this point, there are stresses piling up in China’s corporate sector. Do you think it’s going to worsen from here?”
Vincent Chan says, “The simple answer is: It will, because in the past, default was basically not allowed in various types of financial products – no matter [if] they are bonds, or trust products or wealth management products.
“But I think the government kind of makes it clear that they want to see market discipline to come back. So you start to have defaults. And the economy slowing, which means that the debt – including in sectors like mining and industrial processing or whatever – will become quite vulnerable. I think, indeed, the first vulnerable part of Chinese debt problem will not be local government, but in sectors like coal, cement, steel – those kinds of areas. So to answer your question it’s that it definitely will worsen. I think that it will.”
It All Starts in the Home
Tara Joseph says, “With this in mind, what’s going to be the knock-on effect to the financial system. What sort of stresses will we see there?”
Vincent Chan says, “The biggest risk… What I see is that if you have some local governments start to default, or they need to slow down their new investment activities in order to bring their house in order, and then you start to affect the confidence of Chinese households on property… which they start to, property price starts to correct very meaningfully, developers at least stop building new projects.
“Then you trigger a more severe economic slowdown in the economy, which then affects 50 to 60% of total loans which is 70 to 80% of GDP, that type of industrial loans. Well, then if you have all these things happen together, we have a pretty serious trouble.”
Property: The Deciding Factor
Tara Joseph says, “So that biggest risk you are talking about, how likely is it? More than a 50% chance, more than 75%?”
Vincent Chan says, “Well now, I think some default of local government is a given. But given the fact that these are pretty easy to control, because at the end of the day… they are all government entities to a large extent, it’s manageable. The one unknown, the single unknown I have which, to answer your question, the single unknown whether you will have this kind of feed off each other credit event is property.
“In the last ten years, Chinese households buy property largely because they believe that prices will continue to go up. So people have three, four properties per person, for the middle, high-middle class. If this expectation changes, well then the second I talk about will come along. And the local government debt plus property – if they come together than the risks will become very high.”
What Exactly to Expect for China’s Future
Tara Joseph says, “So are you actually lowering your growth forecast for China?”
Vincent Chan says, “I think 7.5% is even in the best-case scenario seems to me to be not achievable. Seven, maybe, if we don’t have a serious credit risk. If we have a serious credit risk then we don’t know.”
Tara Joseph says, “You talk about the biggest risk. What are the chances of this actually happening?”
Vincent Chan says, “Well, I would say that it definitely will get worse. I just don’t know how worse it will get. That I don’t know. Because it really, at the end of the day, I want to highlight a point that China has a central bank that has the capability and has the willingness to be the lender of last resort. When will it decide to step in? We don’t know. So it will get worse. There is a 100% chance, 100% chance things will get worse.”