Great Expectations

China's Tale of Two Cycles

Don't be fooled by accelerating GDP growth. Leverage is still a big problem.

A business cycle upswing is giving the impression that China's financial vulnerabilities are also on the mend. Yet the evidence in support of this cheery view is patchy at best.

Since financial booms and busts play out over a far longer horizon and have a bigger amplitude than more frequent waves in corporate sentiment, a dose of skepticism about runaway leverage in the People's Republic is still warranted.

It's easy to get taken in by GDP growth, which accelerated for a second straight quarter. Figures released Monday showed the economy grew 6.9 percent from a year earlier in the first quarter, better than the 6.8 percent expansion recorded in the three months to December.

The property market is undoubtedly playing a large role. Fixed-asset investment excluding rural areas swelled 9.2 percent in the first quarter, accelerating from 8.1 percent growth last year.

Chalk up that gain to the business cycle, however. Financial weaknesses in this leading sector of the economy still persist. A yield curve derived from prices of more than 100 U.S. dollar-denominated bonds issued by Chinese developers shows investors demand a significant premium over Asian financial firms' BBB-rated notes, across all maturities.


Chinese builders' bonds yield significantly more than their Asian financial peers

Source: Bloomberg

*114 dollar bonds issued by members (including parents and subsidiaries) of BI China Real Estate Owners & Developers Competitive Peers Index.

For the creditworthiness problem in Chinese real estate to abate, home buyers need to keep biting. As they take out more loans, builders' cash flows get a boost. A 25 percent increase in bank advances to households in March shows they're doing exactly that, with the benefit of their optimism flowing over to highly indebted developers like Guangzhou-based China Evergrande Group, which reported a 32 percent jump in contracted sales last month.

All About Property

Mortgage demand is pushing household debt higher, while corporate loans languish

Source: Bloomberg

Evergrande's shares are up 71 percent this year, though one of its new dollar bonds maturing in five years still pays 7.2 percent, compared with 4.7 percent for Chinese developers on average and more than double the 3.1 percent yield on a Bloomberg index of Asian financial companies' notes.

Given authorities' stop-and-go attitude to housing bubbles, it's doubtful if the property mania will endure. Besides, with monetary conditions getting tighter in China, the business-cycle upsurge is starting to look exhausted even as banks' corporate advances are showing only the slightest hint of improvement. 

Not Much Juice Left

Typical business-cycle indicators are signaling a peak

Source: Bloomberg Intelligence; Shanghai SteelHome E-Commerce

It will take a protracted business-cycle recovery to reduce what Bank of Communications Co. President Peng Chun characterizes as huge pressure on asset quality. Since that's only possible with real-estate investment remaining strong, developers like Evergrande -- Asia's largest junk note issuer this year -- will likely bet that authorities in Beijing will remain reluctant to stamp out  demand for new homes with monetary overkill.

That may be a rational gamble, but it's still all about keeping the business cycle going while expecting the financial cycle to lose its sting. Which could be hoping for a bit too much, a bit too soon.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

    To contact the author of this story:
    Andy Mukherjee in Singapore at

    To contact the editor responsible for this story:
    Katrina Nicholas at

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