Is the Evergrande Crisis a Contagion Risk?

some stability in the markets but you know what we still have no greater clarity on the end game the risk remains thanks very much for uh for having me on the program it's great to see you both again so let's take care of the easy conclusions first the easy conclusions from a jpmorgan perspective are number one evergrand is still likely to default number two this is not a company specific issue this is a structural issue that impacts the entirety of the chinese property developer space number three this will not become systemic to support that last conclusion which is probably the most contentious of the three i would suggest a couple of different numbers for us to look at number one total outstanding commercial bank loans to the china property development space is about 10 trillion rmb if i look at loan loss reserves on the balance sheets of chinese banks it's about 5.4 trillion rmb and they make an additional roughly 2 trillion rmb a year so unless you assume a massive default ratio on the entire body of commercial and residential property development loans that sit in china today this is not a systemic risk therefore we see potential buying opportunities in less levered developers with lower inventory levels and we but we do not see this as a contagion risk for the rest of the region at all not systemic but is it time to rethink china's growth i mean if you take a look at property it accounts for about 25 percent of gdp that's massive and it's not just that it's an absolutely critical question so thank you for asking it the right conversation to have on evergrand is not the impact on the property development space the right conversation to have with evergrand as you rightly hint is the overall impact on economic growth but also the structure of tax collection and revenue generation for the chinese government as we all know a very high degree of revenue generation is driven by land sales on jpmorgan calculations that was roughly about uh eight to ten trillion rmb in land sales primarily by local governments last year interestingly there's this impression that china is such a centralized economy from a government spending perspective however it's shockingly decentralized and so those provincial level land sales are critical if we are now saying that household formation will structurally slow based upon a delay of marriage based upon lack of of of fertility rates based upon ultimately a falling population over the course of the next 10 years then that revenue generation source is clearly in question and so the right conversation i have here is what are the what is the central government as well as the provincial government is going to do to restructure the entirety of the tax code to be cognizant to the structure of the chinese economy on a go-forward basis also as you as very rightly say construction has been a primary driver of the economy for many years they lose that lever moving forward james that you're highlighting some of the structural shifts taking place why have they occurred in a bit more detail james and again just a little bit of a read through as to how that will affect growth for looking forward sure so you can definitely say that the chinese chinese government loves its slogans but the one thing that i would not do is to discount them as meaningless and so when the chinese government talks about things like common prosperity those words have meaning and that meaning is expressed in policy and in this instance you're looking at very significant rising levels of income inequality in china and like most markets in the world that's largely driven by asset differentials 90 of chinese are homeowners you have a generation of chinese that are beginning to believe that they will never become homeowners because of lack of affordability and the government is in many ways justifiable in stepping in to start to curb that excess one of the conversations that we've had with investors is the chinese government has very clearly learned from the experience of japan several decades ago is looking to take the top off a housing pricing bubble and start to start to create a more affordable housing environment moving forward i just want to get a sense of you know what happens next as well you know with evergrand and and the like because i mean some have likened this as beijing orchestrating a controlled explosion and one which sends a message to the wider property market and saying you better adhere to those three red lines that we had which of course target liability levels we've got leverage and liquidity in other words do we then look for the next shoe to fall in the property market of a developer let's say his liabilities are higher than 70 percent of its assets and net debt perhaps exceeding the value of its equity and short-term borrowing growing larger than its cash reserves and those are the three red lines essentially so i've always been a very firm believer in efficient markets and i think in this instance we have a very clear example of that and so while well evergreen uh publicly traded bonds are trading at about 20 cents to the dollar we have a slew of other chinese property developers that are trading at 40 to 60 cents on the dollar and so the market i would suggest is cognizant of of what you've just suggested and as we said at the top of the program this is not an idiosyncratic or company specific issue this is an issue that will face the entirety of of this sector and we need to watch those those debt levels work out uh moving forward jp morgan baseline forecast is that we will see a more stable house price environment in china uh with significantly reduced volatility and so we're not going to see the type of upside that we've seen over the last two decades james what will the fed say in your view and does it move the dial in any way so so again let's take care of the easy stuff first and then talk about the more interesting bits the the easy part of the conversation at least from a jp morgan perspective we will see uh tapering in november we will see a rate one rate hike in 2022. jpmorgan forecast call for three additional rate hikes in 2023 and critically we'll get the first look at the 2024 dots uh from the fed governors in this announcement jp morgan forecast has three rate hikes in 2024 as well so a relatively aggressive stance that does imply a steeping seeping of the yield curve from where we are today and potential outperformance of both financials as well as cyclical stocks the more interesting conversation though i think is this battle that we're seeing across global markets between monetary and fiscal policy in the u.s you will very clearly see a rate cycle that will be more defined by the end of this week than it has been in some time if i contrast that to what we're seeing in markets here in asia however you're seeing significant fiscal thrust in markets like china and india in both markets you're seeing government government tax receipts come in significantly ahead of expectation to the tune of 25 to 30 percent in a market like india that's translating to to central government capex in the second half up 30 year-on-year even more from state government up to 37 year-on-year so it'll be interesting to see how these dynamics play out so james you know the thing is the fed has made it rather clear that announcing that they're going to be reducing their bond purchases it does not signal they're going to be essentially raising interest rates anytime soon which is a mistake that was made in the last tapered tantrum right so they manage this pretty well what do you think i think they have managed expectations quite well the only caveat to that would be i do think that we'll see that increase that you just hinted at in terms of the potential for a 2022 liftoff and then an acceleration into 2023 and 2024 we are talking about number uh dates however they're two years away and so in terms of expectation management we think they are doing a good job the lack of volatility that you've seen in rates markets recently i think is a good sign of that james i'm just wondering what assessment of the taper risks what will it take to derail the u.s economy and get you know the fed back to square one i think if you see one of two things coming to the fore one of the things that we've seen in our own jpmorgan economist estimates in terms of the strength of the u.s economy is a significant reduction in gdp growth estimates as we've worked our way through 2021. the the real key surprise here however is the fact that the services sector has not come back in a very significant way and from a forecasting perspective one of the things that we've looked at for the past couple of years are mobility statistics to try to better understand the impact of covid on overall consumer spend historically that relationship has been quite strong but it is breaking down in a significant way and at least at jpmorgan we think that that breakdown is triggered by a significant reduction in consumer confidence and we very clearly see that in the numbers coming particularly out of the united states if we do not see this transition away from the goods portions of the economy into the services portion of the economy we could see the us gdp growth missing expectations as we look forward into next year

Channel: Bloomberg Markets and Finance

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Length: 9min 13sec (553 seconds)

Published: Tue Sep 21 2021