Year of the Tiger in China or the real estate crash?

In China, the housing market has been thrown even further off balance than in the United States when the housing bubble burst. Whether this imbalance will lead to the same misery as the financial crisis of 2009 depends entirely on the decisiveness of the Chinese government.

China is claiming a major role in the international news flow this week. The Olympic fire will be lit in Beijing tonight. The coverage of the Winter Games is a pleasant distraction from all the corona news. Last Tuesday, the Year of the Tiger was ushered in during the Chinese New Year. The tiger is a symbol of courage and strength in the country according to astrology. Those qualities are sorely needed in tackling economic problems the country is grappling with. Because although it has been remarkably quiet around the faltering real estate giant Evergrande lately, the danger to the Chinese economy has not yet passed.

Very wrong signal
Looking purely at Evergrande's numbers, it shouldn't be a problem for the government to contain the financial damage. The company has approximately 130 billion in outstanding accounts with suppliers. In addition, Evergrande has approximately €80 billion in debt. If all legal obligations are also included, the potential loss amounts to more than €260 billion. That is about 2% of GDP, so that the government can untangle the financial knot without major problems. The major disadvantage of this solution is that it sends a very wrong signal. As a real estate company, why would you still try to exclude risks if the government does step in when things go wrong?

Chinese housing bubble
On the other hand, making Evergrande implode is not an option either. In that case, suppliers and banks will get into trouble. If these companies are also unable to meet their obligations, the oil slick will spread very quickly. Due to the bubble in the Chinese housing market, such a blow can come very hard. In Beijing, the average selling price of a home is no less than 25 times higher than the average income. In the rest of the country, that ratio is 12,5. When the dominoes started to fall on the American housing market at the start of the credit crisis in 2008, the house value was 'only' 7 to 8 times higher than the average income. For the time being, very little attention has been paid to this risk on currency markets. The renminbi has taken a small step back at the end of January. But against the dollar, the currency is 3% higher than at the beginning of April

Renminbi is remarkably strong
The strength of the renminbi has everything to do with the recovery of the global economy – which benefits China as an export superpower – and with interest rate differentials. The Chinese central bank applies a rate of 3,7%. That compares very favorably with the 0,25% in the United States. In Europe it is even -0,5%. However, it can be seen that the difference will become a lot smaller in the course of 2022. The Federal Reserve appears to be gearing up for four or more rate hikes, while the Chinese central bank may cut interest rates to prevent real estate problems from putting too much of a drag on economic growth. There is therefore a good chance that the year of Tiger will turn out less well for the renminbi than the recently concluded year of the Ox.

Joost Derks

Joost Derks is a currency specialist at iBanFirst. He has over twenty years of experience in the currency world. This column reflects his personal opinion and is not intended as professional (investment) advice.

© DCA Market Intelligence. This market information is subject to copyright. It is not permitted to reproduce, distribute, disseminate or make the content available to third parties for compensation, in any form, without the express written permission of DCA Market Intelligence.