SINOWEEKLYPLUS

Trump squeezes China with trade and religious freedom; China’s industrial profits didn’t grow 15% in early 2018

SinoInsight 1
The U.S. dollar keeps strengthening in recent weeks (the dollar index broke the 95 level on May 29) and could keep growing stronger (the Fed is expected to raise interest rates in June).

The strengthening dollar has led observers to believe that there would be continued shorting of the Hong Kong dollar. Already the Hong Kong Monetary Authority has entered the market 19 times and purchased over HKD 70 billion (about $8.97 billion) in Hong Kong dollars to prop up the currency. Meanwhile, property prices in Hong Kong have been falling across the board. Large units plummeted by 3.21 percent within a week, while monthly data reveals a huge drop of 2.09 percent.

OUR TAKE 1. According to a Daiwa Securities report, Hong Kong’s banking system would face liquidity challenges when capital outflows exceed $155 billion. We believe that while China has $3 trillion in foreign exchange reserves, it may not be enough to rescue Hong Kong. That is because the Chinese economy is itself in bad shape, with over half of foreign exchange reserves being foreign debt. Also, China’s foreign exchange reserves are becoming more illiquid with the interest rates of U.S. Treasury bonds on the rise.

2. Property value in Hong Kong is falling at such a rate that large units may lose as much as 20 percent of their value in 2018. If Hong Kong’s property market collapses, its economy would be in serious trouble.

3. We believe that the Hong Kong government cannot avoid raising interest rates and tighten land supply to stabilize property prizes. Raising interest rates, however, would see the property and stock markets take a hit.

SinoInsight 2
A strange phenomenon has been occurring in China’s real estate market. On the one hand, property prices are hot and unsold units are scarce in second and third-tier cities. On the other hand, property stocks have fallen across the board. Official data shows that real estate investment and sales in the first quarter of 2018 have dropped year-on-year.

OUR TAKE
1. Presently, the debt ratio of property developers has gone past the red line. In 2018, the average debt of over 120 listed property developers has exceeded 80 percent, reaching the highest level since 2005. By the end of Q1 2018, Shenzhen Vanke’s total liabilities hit 1 trillion yuan and its debt ratio reached 84.04 percent, a new record for the company.

2. The recent wave of bond defaults across China makes it more and more difficult for property developers to secure financing. Even if developers secure debt financing, the cost of financing would be very high.

3. We are not optimistic about the liquidity of China’s foreign exchange reserves, particularly when a strengthening U.S. dollar would encourage increased capital outflows.

Currently, the total market value of China’s real estate is about $43 trillion. In a scenario where 1 percent of the total market value is traded for U.S. dollars, China’s foreign exchange reserves would come under catastrophic pressure. Beijing is likely aware of this scenario, and to guard against it, Chinese state media continues to encourage the populace to buy property to transfer the debt burden to residents. Concurrently, Beijing introduces policies to lock up capital in the property markets and curb the outflow of capital.

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