Risks mount in China, from Evergrande to trade

The crisis around Chinese developer Evergrande Group is a “calculated risk” on the part of the Chinese government and unlikely to be a systemic risk to the global financial system, CIBC Asset Management’s chief investment officer says.

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“Some have equated the failure of Evergrande as the equivalent of the Lehman Brothers bankruptcy,” Luc de la Durantaye said. “We don’t share that view and think that China will manage the real estate deleveraging without leading to a systemic crisis, per se. We have to remember that the financial system in China is fairly closed, and the spillovers into the global economy should be limited.”

Vjosana Klosi, director of portfolio construction at CIBC Asset Management, said the Chinese property sector’s “current implosion” risks spilling over, but she also said the crisis is probably not systemic.

On Friday, China’s central bank said that financial risks from Evergrande’s debt problems are “controllable” and unlikely to spill over.

To understand the repercussions of the property crisis, de la Durantaye said one must first consider China’s growth model over the last 10 to 15 years.

“China has been leveraging its economy with very rapid credit growth over that period,” he said. “The business model of Chinese companies was not necessarily to maximize profit, but to maximize the size of their companies, which led to an unsustainable trend in credit growth in China.”

China recently shifted its focus from all-out economic growth to the quality of that growth, de la Durantaye said. “Going forward, it will mean that you’ll have slower growth coming out of China, which is the negative aspect, but also you’ll have less leverage that the economy will be deleveraging to a certain degree, which will make the economic activity in China more sustainable.”

It is through this lens that de la Durantaye calls the Evergrande failure a “calculated risk,” and said he believes China will be able to manage the crisis.

China’s focus on “common prosperity” aims to redistribute resources and double income levels by 2035, Klosi said. The policy has led to more government intervention, with a crackdown on large tech monopolies such as Alibaba.

Government intervention has hurt equities markets, she said, with China underperforming developed markets by about 25% since the start of the pandemic.

De la Durantaye linked the tech crackdown to trade tensions with the the U.S. Following restrictions from the U.S. and other governments on Chinese tech leader Huawei, de la Durantaye said the Chinese government realized it was vulnerable on a number of fronts including semiconductors. According to de la Durantaye, China spends roughly US$30 billion on semiconductor imports per month.

“China wants to divert investments toward developing an expertise in semiconductors,” he said, to reduce vulnerability to the U.S. Trade policy and technology regulation “is all aimed to change the focus within China in becoming more independent in semiconductors.”

The same is true for China’s dependence on foreign energy, de la Durantaye said, where massive imports of oil, coal and natural gas also leave the country vulnerable.

Chinese government intervention in monopolies will create divergence, Klosi said, which may lead to opportunities for active managers.

“In general the view is that investing in Asia and emerging markets is a long term beneficial investment strategy,” she said.

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