How will China ease policy in response to the power cuts and Evergrande?

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by Shaun Richards

2021 was not supposed to be like this. The narrative for 2021 was that the Chinese economy would pick up strongly after the Covid-19 pandemic and be a leading indicator for the rest of the world.  But the reality as we have been observing for a while now is a Chinese economy which is stuttering. Some of the factors are related to Covid but others have appeared to. We can start today’s journey with something that was claimed to be a big bang a couple of weeks or so ago and was instead more of a damp squib. But as Taylor Swift would sat there is “Trouble,Trouble,Trouble”

Shares of China Evergrande Group, the world’s most indebted property developer, and its property management arm were suspended on Monday in Hong Kong ahead of a potential sale of a controlling stake in the property management business, signalling a move to dispose of core assets as it seeks to stave off a debt crisis. ( South China Morning Post)

On the income side things are getting worse.

At least a third of these homes under development have been pre-sold, but it may be difficult to sell the rest to generate cash because of the uncertainty surrounding Evergrande’s future, according to CGS-CIMB Securities’ Raymond Cheng.

“It has to offload its assets – lands in particular – to keep the last hope of continuing paying on time,” Cheng said. “It can only sell the completed homes now to collect money, with large discounts.” ( SCMP)

But debts have to be paid ( well eventually as some payments have been missed) but the saga is a familiar one as we note lumpy and slow income but short-term debt.

“One of the key issues that caused Evergrande’s distress is essentially their capital structure. Compared to other developers, Evergrande has relied more on short-term debt, in terms of the debt [and] in terms of the borrowings. Not only that, they have also relied heavily on trade payables,” said Adrian Cheng, co-head of China properties at Fitch Ratings. “When things go haywire and liquidity dries up, you basically get into a very difficult situation.”

In a sense Evergrande has followed the banking model of lending long and borrowing short. In some form therefore we expect a bailout but the issue has had consequences.

The Evergrande crisis has already

caused borrowing costs to soar

for China’s property sector ( SCMP )

So there is an element of contagion which is another reason why establishment’s are always so afraid of dealing with a property boom because it so quickly becomes a bust. This has hit the Hong Kong stock market quite hard.

Hang Seng Index Closes 2.2% Lower at 24036.37 Hang Seng TECH Index Closes 2.1% Lower at 5973.80 ( @marketstoday )

That is a signal because Chinese markets are closed for several days for their version of Golden Week. Which of course as my financial lexicon for these times is exactly when you complete a bailout. However it leaves us with a Hang Seng Index which in round numbers made 33,000 in futures terms at the start of 2018 and 29,000 on the post Covid rally but is now below 24,000.

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Power Cuts

These is a theme spreading around the world and one factor in play is the shortage of coal. China rather shot itself in the foot on that front with its trade war with Australia. Now we are seeing several consequences.

HONG KONG—China is struggling with widespread power shortfalls, dealing a blow to the recovery of the second-largest economy and risking disruption to global supply chains and heightened inflationary pressure around the world. ( Wall Street Journal )

This morning it is hitting the price of coal.

Shortage of natural gas supply, the decrease in electricity production from renewable sources and China’s decision to import less coal from Australia pushed coal prices to new highs, reaching 180 dollars per ton in Europe. ( AA Energy)

Rather curiously as they then explain China has created a supply shortage via this policy.

The disruption didn’t change the need for coal globally, it just changed the patterns and route of coal distribution, he added.

As China started buying coal from other countries, Australia turned to new customers. New buyers means the coal travels a longer distance to reach its destination, thus increasing the delivery time and increasing the prices accordingly, Ricketts said.

The combination of this and higher prices is causing trouble for India.

Over half of India’s 135 coal-fired power plants have fuel stocks of less than three days, government data shows, far short of federal guidelines recommending supplies of at least two weeks. ( Reuters )

Also the feedback is raising prices.

However, coal from Indonesia, one of India’s major suppliers, rose from $60/ton in March to $200/ton in September, discouraging imports. ( Financial Times)

The Economy

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The Caixin Manufacturing PMI at the end of last month was slightly curious.

Latest PMI data indicated that business conditions across China’s manufacturing sector stabilised in September, after a slight deterioration in August. The improved headline index reading was supported by a renewed upturn in total
sales and a softer reduction in output.

So output fell again. There is I think another factor in play.

“Inflationary pressure surged. The gauge for input prices hit its highest level in four months in September, its 16th straight month in expansionary territory. The measure for output prices also reached its highest in three months. Surveyed enterprises said the rise in costs was mainly caused by a sharp increase in the prices of energy, industrial metals and electronic raw materials. The pressure of rising costs was partly transmitted downstream
to consumers, as the demand was not weak.”

There is a squeeze coming here with cost pressure but an official consumer inflation rate of CPI of 0.8%. Yet somehow this is happening.

the demand for consumer goods was weak, reflecting consumers’ lack of purchasing power.

So consumption is weak.

Comment

There are several factors which will rebound off each other here.The energy crisis is both contractionary and inflationary. As prices rise for energy consumers will be hit and we have just noted that consumption is already weak.That is awkward because official policy is to boost consumption to both fire up the economy and to rebalance it. There is an irony here for UK readers because we were rebalancing according to former Bank of England Governor Baron King of Lothbury except it was in the opposite direction.Also it never happened partly due to his policies.

There is another clash here because the squeeze on property and house prices which has caught out Evergrande will in the short-term be bad for consumption too.Thus the Chinese have been too clever by half. We know what happens next which is that they will ease policy but how they will present this is more problematic. One route might be to reverse the rally in the Renminbi as at 6.45 to the US Dollar it is up 5% over the past year. In which case it should order and pay for some Australian coal first.

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