By Sean Mei, Founding Partner, Partners Trust China.
China’s growing debt problem is very real and of major concern to both institutional and individual investors in China. Generally, there is still confidence by investors in China in central government’s ability to manage this situation. However, how exactly central government intends to manage the debt and credit situation remains unknown to the general public, and this is not entirely a domestic issue but one that is impacted by various world events.
Most notable among these, the uncertainty created by Brexit, the surprising US Presidential election and the on-going elections in Europe, and of course the continuing crises in the Middle East all combine to make it difficult to predict if China’s government strategy will be successful.
Institutional investors and individuals are doing everything they can to diversify their assets and are readying themselves to move as much as they can to markets such as the US, Australia, Europe, the UAE and South America.
China’s central government has been preparing for this dilemma since 2013. The State Owned Enterprises (SOE) that account for such a large share of the debt, have for the past three years been instructed to go overseas. The SOE problem is a complex one. On one hand they have the potential to collapse China’s economy, however on the other hand they also are the main tools through which China can manage employment, investment, debt/credit and the distribution of wealth and are thus still necessary.
China has been open about its intent to change the nature of its economy to a consumer driven economy rather than being reliant on heavy industry and manufacturing. This obviously takes time, and China gave itself about 15 years to implement this change. While the debt to GDP ratio now is approaching the level of the US (close to 300%) while the SOEs are re-inventing themselves, there are fundamental differences with US debt.
The difference between China’s debt and US debt is both the nature of the debt itself and who the debt is owed to. Most of China’s credit is provided by their own banks. These banks are also state-owned and, while some may balk at executing some debt for equity swaps, they really do not have much choice. It’s worth noting that in the last three months, not only were the top executives of two of the four largest banks in China replaced but also, the Minister of Finance last month. The newly installed leaders are more likely to fall in line with central government’s financial policies.
I believe ultimately, the situation will be managed. However this does not change the fact that investors are nervous and just to hedge their bets, they are en masse preparing to move funds overseas. This potentially will dramatically increase the demand for US real estate and specifically California real estate in 2017. Combine that with the uncertainty about any new policies by the Trump administration, and I think that this demand will increase sooner rather than later, in the first half of 2017, with Chinese investors hunting for bargains and safe haven-type investments.