In the last month, China’s highly successful private tutoring companies and many of its top tech companies, including entertainment giant Tencent, online retailer AliBaba and ride hailing app Didi, have all fallen foul of new Chinese government regulations and faced sharp share price falls. Meanwhile the second-largest Chinese property company Evergrande, which has now broken all four ‘red lines’ of prudential guidance issued by the central bank, has had its share price collapse by two thirds and its bond rating slashed to just above junk grade.
With the Chinese economy of similar order of magnitude in nominal terms to the US economy and much larger in PPP terms (and hence the dominant importer of most primary commodities), the stability of the Chinese economy is of importance not only to China.
As ever, Westerners speculate about motives. Kamikaze is not a concept generally associated with the Chinese. So what is going on?
The Cebr interpretation of this is less apocalyptic than that of some observers. We think two motives are at work, both intended to increase longer term stability. The first is a sense by the Communist Party that Chinese companies have played fast and loose with rules and have used western listings and VIE (virtual interest entity) listings to evade local laws. This both created risks and vulnerabilities which, if left unchecked, could put the whole system at risk. The second is that the scale of the borrowing that has partly fuelled Chinese growth since the 2008/09 financial crisis has its own risks and the authorities have been keen to defuse the credit bubble before it creates serious problems.
Evergrande has played an intrinsic part in the Chinese property boom. Because markets for other assets are less well established in China than in the West, many Chinese prefer to hold property as their main long term assets. In addition, it is possible to own property through nominee companies which means that undeclared sources of income (which remain considerable in China) can be laundered through the property market.
The result is a substantial economic dependence on the property market with the average residential property worth 28 times average income (compared with an equivalent ratio of 9.5 for the UK, itself often accused of having expensive property). Combined with a standard model of housing development in the East where the development is financed by advance payments from potential purchasers, the potential for damage if the market collapses is considerable. And according to a 2016 article in Forbes magazine, 15% of Chinese residential property is fully paid for in cash, often transported in bulging suitcases.
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Our guess is that the authorities are allowing a cooling of the property and other markets now as part of the price that they are prepared to pay to reduce the medium term risks to the system of a much larger collapse. And that they are trying to limit exposure to Western markets for a range of reasons, both political and economic.
While this adjustment is taking place, companies’ ability to raise capital will be more limited and bank lending more constrained. Both will reduce economic growth temporarily and we are revising down our Chinese growth forecast for 2021 and 2022 by about 1 percentage point each year. But the Chinese authorities will feel justified if a temporary dip enables them to avoid a more serious downturn, a risk that might have been reinforced if the West were to have an inflationary boom and bust at some point in the next decade.
Gordon Brown famously claimed to have ‘abolished boom and bust’ just before the evidence emerged that he had not. Might the Chinese authorities have succeeded where he failed?
Douglas McWilliams is Deputy Chairman of the Centre for Economics and Business Research (Cebr).