On the matter of misvalued Chinese land | FT Alphaville

On the matter of misvalued Chinese land

Phew..! What a relief.

The Chinese danger is no more.

As we all know by know, data released on Wednesday categorically confirmed that Chinese growth had defied recent tightening measures by monetary authorities and continued on track in the second quarter at 9.5 per cent (thus saving the world).

Understandably, markets reacted positively.

After all, whatever concerns might exist about Chinese debt levels are notably reduced in a scenario of continuing economic growth. If GDP is rising, debt simply isn’t the problem it would be otherwise. This is especially the case when the official finance ministry debt level is only about 17 per cent of GDP.

Though, naturally, things could change if those percentages were to hit the more unsustainable realms of European-style debt ratios.

Indeed, when it comes to Chinese debt, it’s definitely the country’s contingent or indirect liabilities that become the elephant in the room.

Some estimate that when such liabilities are taken into consideration China’s debt-to-GDP rises to a much more European-esque 70 per cent.

What’s more, on the local-government liability front, as we have noted at FT Alphaville before, there’s growing proof that some unnerving black holes are potentially brewing too.

Bloomberg reports on Thursday, for example, that urban developments in China may be being funded with bonds backed by grossly misvalued land assets — eery echoes of the misvaluation craze that afflicted America ahead of its subprime crisis, some might say.

In the little-known Chinese city of Loudi — which is home to 4m people —  there is a 1.2bn yuan ($185m) leisure project currently being developed, money for which was raised through bonds guaranteed by land valued at $1.5m an acre. Those prices, says Bloomberg, are comparable to acreage values in one of Chicago’s plushest suburban neighbourhoods.

More than 400 billion yuan of municipal bonds sold since 2008 — part of as much as 14.2 trillion yuan in local borrowing — show how much local officials rely on their own forecast that land prices will continue to rise. Efforts by the central government to cool the property market so far have had no impact on their bullish estimates.

As to the structure of the financing deals:

Local governments set up more than 10,000 so-called financing vehicles in the past decade to get around laws prohibiting them from taking direct loans. One third of them don’t have cash flow to service their loans, China’s banking regulator says. The similarities with special purpose vehicles in the U.S. hiding toxic repackaged mortgages from banks’ balance sheets are increasing.

All of which, they note, could present a bit of a problem if cashflows decline or land sales slow:

“It’s a huge myth that land sales are going to be able to even support the interest payments let alone the principal payments,” says Stephen Green, the Hong Kong-based head of Greater China research at Standard Chartered Plc. (STAN) His research team assumes that at least 4-6 trillion yuan of local government loans — and possibly much more — will ultimately not be repaid by the projects, Green wrote in a June 29 report on China’s debt.

Meanwhile, in a worrying first sign that things might not all be as well as they first appear, Sean Corrigan, chief investment strategist at Diapason Commodities Management refers us to one second-quarter statistic which hasn’t done well at all: Chinese urban fixed asset investment (year-on-year) — which refers to the volume of activities in construction and purchases of fixed assets in monetary terms (including real estate development).

As can be seen below there’s been something of a negative turnaround of late:

Not good for the future of land values.

And a good reason to resist popping open the champagne just yet.

Related links:
Moody’s warns on China’s local debt
– FT
Waiting for a Chinese local debt disaster – FT Alphaville
China’s uncollateralised, cash flow-less, local government loans – FT Alphaville