China’s bond market: Japan, the third-largest economy in the world, is moving ahead with a single-point agenda – to destroy the Chinese economy. Over the past one year or so, it has taken a number of steps to hurt China.
- Japan set aside $2.2 billion to move Japanese companies out of China last year.
- Japan blocked China’s entry into the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP), the largest trading bloc in Asia-Pacific.
- From Toshiba to Oki Electric Industry Company (OKI), Japan is also pulling its electronic giants out of China.
- Japan has also made an attempt to kick China out of global supply chains by aligning with India and Australia.
And now, Japan has inflicted another blow on China. Japan’s Government Pension Investment Fund (GPIF) has announced that it will not invest in Chinese government bonds. This is bound to create a ripple effect as GPIF is one of the biggest institutional investors in the world. When an institutional investor of such a gigantic size cancels a bond market, it leaves a major psychological impact on the smaller investors.
Why Japan has cancelled China’s government bonds:
Interestingly, China’s bond market opened up to the world only in November 2020. In March, British index provider FTSE Russell decided to include Chinese government bonds in its benchmark FTSE World Government Bond Index (WGBI). Still, Japan’s GPIF has cancelled Chinese government bonds.
GPIF has decided to stop adding the Chinese government bonds to its portfolio owing to the uncertainties in the Chinese bond market and other factors. Naturally, this move comes after the Evergrande downfall in China and an impending crisis that awaits the Communist nation as its real estate bubble bursts.
The Evergrande crisis and China’s real estate bubble:
The downfall of the Evergrande Group, China’s second-largest real estate developer and most highly indebted property developer in the world, is a sign of an impending crisis in the Chinese economy.
The Evergrande episode is China’s Lehman moment. It exposes how big China’s real estate bubble is and how bad its debt crisis is.
- As per Rushi Advanced Institute of Finance, condominium prices in China’s Shenzhen are 57 times the average annual income.
- Condominium prices in Beijing too are 55 times the average annual income.
- Real estate loans account for just under 30%of China’s outstanding loans.
- The private debt-to-GDP ratio has hit a whopping 220% in China.
Xi Jinping’s tight regulatory measures heating the bubble:
Meanwhile, Chinese President Xi Jinping is taking some radically Communist measures.
- Xi is cracking down on tech giants, edutech enterprises and a host of other businesses.
- Xi is also running what he calls a “common prosperity” campaign.
- Xi’s radical ideas like intimidating businesses and forcing equitable distribution of wealth are hampering China’s investor sentiment.
All of Xi’s imprudent measures have heated the real estate bubble and the debt crisis in China. Instead of cooling the real estate bubble, Xi is popping it which could create further problems for the Chinese economy.
How the Evergrande downfall will affect the Chinese bond market:
HSBC CEO Noel Quinn has been quoted in a Bloomberg report as saying, “I’d be naive to think that the turmoil in the market doesn’t have the potential to have a second-order and third-order impact. Clearly, with the changes that are taking place in the Evergrande situation, it’s concerning. There is a potential for second and third-order impact, particularly on the capital markets and the bond markets, and we’ve got to stay close to that.”
Quinn is right. Evergrande holds over a mammoth $300 billion of debt. This forms around 2 per cent of China’s GDP. Now, if Evergrande defaults, it would strike panic in China’s massive $ 15 trillion bond market. This is perhaps what instigated GPIF to cancel the Chinese government bonds.
Why GPIF’s decision to cancel the Chinese bond market matters:
The Evergrande downfall and GPIF’s decision to cancel Chinese government bonds are going to inflict a lot of pain on the Chinese bond market.
China had opened up its bond market last year in the hope that it would rekindle foreign investments in its declining economy. However, Japan’s decision to cancel Chinese government bonds is expected to drive other Japanese institutional investors away from the Chinese bond market.
Any decision by GPIF or any other large institutional investor to cancel a bond market does leave a profound psychological and monetary impact. It is going to make a lot of investors and funds wary of diving into the Chinese bonds.
At the end of the day, small investors tend to study the behaviour of institutional investors. When the institutional investors invest in something, then smaller investors follow. But if an institutional investor cancels a bond market, that market becomes untouchable.
How bad will the impact on China be:
Many are labelling the Evergrande downfall as the Chinese Lehman. But the consequences of Evergrande’s debt crisis could be even bigger and worse. The problem is not limited to Evergrande, rather it has more to do with the real estate bubble that China has created.
With an objective to inflate GDP numbers at any cost, China allowed its real estate majors to rely on indebtedness and construct what has turned out to be a group of ghost cities and unused infrastructure.
Evergrande represents less than four per cent of China’s real estate market. And you may ask if the Evergrande downfall is really such a big deal? Yet don’t forget that the real estate sector is huge in China and directly or indirectly, it forms a quarter of the Chinese GDP. And at the end of the day, it is just a big bubble that can burst any moment and leave a deafening impact on the entire Chinese economy.
Once China’s real estate bubble bursts, you can easily imagine the Communist nation slipping into an economic recession and Japan’s decision to cancel China’s bond market doesn’t give a very good signal for Beijing.