The surge in housing prices in metropolitan China is a systemic concern. A new paper estimates that price growth has been 8-13% per year from 2003 to 2013, comparable to the 1980s housing boom in Japan. Housing prices have averaged 8 times the annual income of buyers, implying a heavy financial burden. Sustainability relies on ongoing high household income growth and low real interest rates.
China’s economy has long relied on compressed interest rates in conjunction with strict capital controls and a tightly managed exchange rate. A new ADBI paper suggests, however, that modest liberalization and gradual internationalization of the renminbi since 2005 have lessened state control over financial parameters. Inconsistencies and risks of market dislocations have become more evident.
A new McKinsey report estimates that total debt of households, corporates, and governments has expanded 40% since 2007, reaching a total of 286% of GDP last year. Government debt ratios will be hard to contain through fiscal tightening and economic growth alone. China’s non-financial debt has quadrupled, with credit quality critically dependent on the real estate sector.
A new IMF paper shows empirically that official currency interventions affect external imbalances and, by implication, exchange rate misalignments. There is a short-term flow impact, which is strongest when capital mobility is low. And there is a medium-term portfolio balance impact, which is strongest when capital mobility is high. Both effects are intuitive and offer lessons for FX trading strategies.
The IMF’s latest staff report on China serves as a reminder of key vulnerabilities. With repressed real interest rates corporate leverage remains high and particularly so in state-owned enterprises. Shadow banking has exceeded 50% of GDP and is still growing. Economic growth and credit quality are exposed to an unbalanced real estate sector. And the augmented fiscal deficit is already close to 7.5% of GDP, due mainly to local governments’ net borrowing through financing vehicles.
Nomura research has summarized evidence of oversupply of residential property in China. Urban floor space per capita is now estimated to be higher than in some developed countries. Land conversion is still rising, while urbanization is slowing. Potential triggers for a sharp correction include interest rate liberalization, capital outflows and property taxes. A plunge in property activity would have serious economic and financial consequences.
Large foreign exchange interventions are common in emerging markets, typically in response to capital flows. What is less well understood is the expansionary (contractionary) impact of FX purchases (sales) on local credit, even if the transactions are sterilized. Sterilization securities mostly end up on banks’ balance sheets, where they function as substitutes for bank reserves, serve as collateral, and encourage banks to expand their loans-to-securities ratios.
The IMF, like other institutions, estimates that China’s fiscal position is much weaker than suggested by headline statistics. A new paper sees the augmented fiscal debt at around to 45% of GDP and the augmented fiscal deficit at close to 10% of GDP. Financial stability risks arise from dependence on a favorable ratio of growth to real interest rates, the reliance of local budgets on real estate sales, and the refinancing of local government financing vehicles’ debt.
A recent BIS paper illustrates the consequences of highly accommodative monetary policy in the G3 for East Asia. These include lower policy rates than warranted by domestic conditions, lower bond yields and appreciation pressure on currencies. Importantly, easy G3 monetary conditions stimulate Asian foreign currency borrowing in many forms, including letters of credit, forward selling of foreign currencies and international bond issuance.
A DB paper suggests that the rising median age of the world’s population will increase savings ratios. The trend is reinforced by macro policies aimed at generating external surpluses or at least restraining deficits. The onus of absorbing the resulting savings glut may fall on the United States, which issues the world’s anchor currency. Irrespective of whether it accepts that role, cost of capital for the world as a whole is likely to be compressed by the savings glut.
Macrosynergy is a London based macroeconomic research and technology company whose founders have developed and employed macro quantamental investment strategies in liquid, tradable asset classes, across many markets and for a variety of different factors to generate competitive, uncorrelated investment returns for institutional investors for two decades. Our quantitative-fundamental (quantamental) computing system tracks a broad range of real-time macroeconomic trends in developed and emerging countries, transforming them into macro systematic quantamental investment strategies. In June 2020 Macrosynergy and J.P. Morgan started a collaboration to scale the quantamental system and to popularize tradable economics across financial markets.
