How the Chinese property crash is affecting Australia’s iron ore exports

The Chinese real estate market is in shambles, but now it’s “doubling” with a risky move – and the impact on Australia could be catastrophic.

When the mining boom began shortly after the impact of the global financial crisis began to be felt around the world, some believed it would last for decades and provide Australia with a magical pudding of prosperity. economic.

What many didn’t realize at the time was how quickly China would develop and what huge role the real estate sector would play in Beijing’s strategy for the Chinese economy.

Between 2011 and 2013, China used more cement than the United States during the 20th century, as it built homes for tens of millions of people and expanded its infrastructure at the fastest rate in history.

But all this growth has come at a cost, the Chinese real estate sector now accounts for nearly 30% of Chinese GDP, a figure higher than even the United States in the midst of the real estate boom before the financial crisis.

With the news of mega developer Evergrande’s failure after months of speculation, China’s real estate-driven economic growth engine appears vulnerable at best. This is a major concern for an Australia which sometimes depends on China which absorbs up to half of its exports.

The property shell game

In recent months, the challenges facing the Chinese real estate industry have intensified as home sales remain weak, house prices fall and the volume of unsold inventory continues to rise.

For the Chinese local government, this is of great concern. With an average of around 40 percent of Chinese local government revenue coming from the sale of land, the sour mood towards property purchases is expected to hit their bottom line hard.

But like so many things in China, things are a bit more complicated than that and quite different from the way they look.

Rather than lowering prices to ensure that all land releases are sold to developers, or drastically reducing the amount of land released to maintain some price balance, Chinese local governments have turned to a new but extremely risky solution. .

In short, effectively buy their own land to ensure a stable income stream.

Using local government finance vehicles (LGFVs) which are public enterprises, local governments can purchase their own land with borrowed money.

The magnitude of the problem

Between July and November, LGFVs bought 13.4% of the land offered by value across China, with some regions relying more heavily on this type of activity than others depending on local demand factors.

With confidence in China’s real estate sector hit the hardest from September, that figure arguably would have been even higher in recent months of falling home sales and falling house prices.

To put these purchases into perspective, about 40 percent of local government revenue comes from the sale of land. Based on this revenue share which remains broadly accurate, about 5.3 percent of local government revenue is now generated by those governments who effectively sell land to themselves.

Peking University professor Michael Pettis recently exposed the risks of this strategy in a Twitter thread.

“These LGFVs are controlled by the local governments and borrow under their guarantees, so that effectively means that the local governments borrow from the banks and treat the proceeds as if it were income.

“I’m surprised this is allowed, but I guess local governments have little choice if they can’t sell enough land to meet income needs.

“But this represents a doubling of the real estate sector. Why? Because if the real estate market picks up and prices continue to rise, LGFVs can then resell the land and make a profit. But if the real estate sector does not revive, the LGFVs will be based on losses that local communities will have to make up.

Risks for Australia

Currently, the different branches of the Chinese government are pulling in two completely different directions. On the one hand, the local government is desperate to retain the main source of income provided by the high standards of the real estate sector and high real estate prices.

On the other hand, the central government led by President Xi Jinping remains adamant that “housing is living, not speculation.”

So far, President Xi and the central government appear to be winning, with no bailout ahead for the sector despite a growing housing stock glut, falling prices, and the potential for the current crisis to become a greater threat.

If Xi continues to refuse to change course, it carries worrying risks for Australia. Currently, iron ore is the country’s most valuable export within a mile and a half and despite persistent difficulties in China’s real estate industry, prices have remained remarkably high.

But if the expected stimulus measures from the Chinese government do not materialize to the extent expected by the markets, export prices and volumes could drop significantly.

What if the CCP is blinking?

If Beijing chooses a different path, deciding instead that it cannot endure the continued economic pain of a struggling real estate sector in such a key political year, the outlook is much better for Australian miners and the federal budget. from the country.

By choosing to add stimulus at a time when commodity price indices are already near record highs, Beijing could end up providing a nice financial premium to Australia despite the current tensions.

With 2022 a very important year politically for President Xi and the CCP in general, the temptation to throw money into the construction industry to iron out economic problems will be immense.

Not a magic pudding

Although the CCP may be forced to withdraw from its current controlled demolition of the riskiest parts of its real estate industry, China’s demand for commodities is not the magic pudding that was once hoped for.

It is a source of demand that has emerged on increasingly volatile ground, as local government in China fiddles with normal financial rules in order to buy land to finance its expenses.

How long this type of activity can continue to grow the Chinese economy remains a source of debate among economists, but one thing is certain, the fate of the Chinese real estate sector and the Australian economy are deeply intertwined.

Tarric Brooker is a freelance journalist and social commentator | @AvidCommenter

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