By Craig Stephen, MarketWatch
HONG KONG (MarketWatch) — As concerns over China are not going away, it’s worth considering what assets are likely to be affected if it is finally forced to call time on its debt spree.
For now, opinions on China’s outlook remain divided, with it being just as easy to point to areas of its economy that are still ticking along nicely, as to others that have already landed hard. Alongside the drumbeat of bad news from distressed heavy or commodity industries, there is still upbeat growth in developing service, digital and various consumer sectors.
One way to navigate these conflicting signals is to follow the money. That is to see where China’s prodigious credit growth — which in March effectively tripled over a month earlier — is causing the most distortions.
It is clearly not being used to ramp up industry, given the unexpected slip in the manufacturing purchasing managers’ index in April, which fell to 50.1 from 50.2 in March.
Instead, once again property appears to be soaking much of this largesse as banks ramped up lending to households. In March borrowing by households accounted for 639 billion yuan ($99.6 billion) of the 1.37 trillion yuan in new loans. Out of that, loans for property reached 440 billion yuan or an increase of 141% month-on-month.
On cue, property transactions and prices have roared into life, with Shenzhen leading the revival as prices rose 63% in March year-on-year. As the market sentiment improved developers have both boosted sales and have also been loading up on new financing.
Property developers were at the front of a new borrowing surge by corporates as bond issuance reached 695 billion yuan in March, up from 87 billion yuan in February.
With their pockets full, developers are now aggressively replenishing landbanks. In Xiamen, 30 developers bid for a land parcel , which ultimately sold for 5.4 billion yuan.
Not surprisingly the recent burst of activity has reignited fears of a bubble. Barclays warned last week that this rally in prices and home sales is likely to reverse course in the next few months.
Indeed, those with memories of 2015 will already see worrying parallels in this frothy property market.
Then again authorities turned on the credit taps early in the year to boost flagging growth, the difference being it was directed at stock margin lending. This led to the subsequent boom and bust in the equities market, which by late summer had wiped some 4 trillion yuan off Chinese equities valuations.
The concern is Beijing is just repeating the same mistakes in a different asset class — boosting prices not economic activity.
The difference, this time around, however, is that any correction could be potentially much more damaging.
An often-repeated argument for the sector is that the government recognizes real estate’s pivotal position in the economy and will support it. But then again, a similar justification was rolled out during last summer’s stock market rally.
Meanwhile, real estate bubbles have a long history of being associated with financial crisis.
In China bricks and mortar is important not just because of its size but also the systematic linkages. Property in some form has been estimated to account for some 50% of bank collateral, while land sales are a major source of local government revenue.
The potential negative impact on bank balance sheets and the wealth of households means the property market is shaping up as the critical swing factor in any hard-landing scenario.
To the extent that consumer spending in more dynamic service industries has become dependent on asset wealth, they will also be vulnerable to a slowdown.
Not only do investors need to watch for signs of any property reversal but also anticipate the potential impact on government policy and investment flows.
Experience elsewhere suggests that to cope with a property bust the government will be on the hook to bail out the banks and need to prioritize policies to avoid deflation. This scenario is the reason some analysts expect Beijing to opt for currency depreciation or a free float as it considers some form of unconventional monetary policy.
If this gets more likely, expect Chinese households to continue to diversify into non-yuan assets where they can. Here gold stands out as a widely assessable store of value, which has recently been trending higher.
By far the biggest impact from the end of China’s extraordinary credit boom is likely to be deflationary, however, due to a punier currency and rehabilitating banks. The impact would extend far beyond Chinese equities.
For instance, it could mean adapting to a world where China is no longer the marginal, price-insensitive buyer of everything from iron ore to overseas apartments and luxury goods.