UBS report highlights series of concerns over Chinese economy

Momentum of translating property sales and new starts into active investment or construction activity remains limited

PUBLISHED : Wednesday, 24 August, 2016, 2:50pm
UPDATED : Wednesday, 24 August, 2016, 8:31pm

The international market is becoming more comfortable about China than earlier this year – but concerns for the world’s second largest economy remain, particularly over weak property investment growth in the second half of the year, according to a new UBS report on the country.

Although the country’s property market has rebounded, the momentum of translating property sales and new starts into active investment or construction activity remains limited, it says in the study.

UBS economists Donna Kwok and Tao Wang have worked out that contract sales and new starts have witnessed double-digit growth in the year to date, at 26 per cent and 14 per cent year on year, respectively.

But construction and investment expanded by just 5 per cent during the same period, with little sign of more pipeline momentum to come.

“Soft property developer sentiment and caution over the longevity of the sales rebound is partly to blame, as is a still-sizeable inventory overhang and sharp land price rally so far this year,” the economists said.

If developer sentiment deteriorates more than we expect, because of much slower sales or the government tightens its policies more aggressively, we could see property construction activity go into an outright contraction
UBS economists Donna Kwok and Tao Wang

“We see property sales and new starts cooling to a mid- to low-single digit growth rate for the rest of 2016, with construction and investment growth holding broadly flat,”added Kwok.

“If developer sentiment deteriorates more than we expect, because of much slower sales or the government tightens its policies more aggressively, we could see property construction activity go into an outright contraction, further dragging down China’s heavy industrial activity and investment, overall economic growth and commodity demand.”

The report adds, however, that a comprehensive property market rebound would be a boost to the Chinese economy, if the current expansion is sustained a bit longer than expected, and property construction or investment growth rises on current levels.

“Property sales growth has stayed strong so far this year. Developers remain cautious for now, but if sales momentum holds up, their construction plans may turn more optimistic to meet strong demand, especially if destocking in lower-tier cities continues,” said Wang in the same report.

“This in turn could support demand for commodities and construction materials, helping to prevent a fallout in related industries following their recent strong price rebound.”

As well as weak property investment growth, UBS said China remains under pressure from capital outflows and continued depreciation of its currency, the yuan, which both present strong potential downside risks.

“We don’t envisage the Chinese government changing its current exchange rate policy stance or allowing the onshore yuan to depreciate against US dollar beyond 6.8 at year-end,” said Wang.

“But we do see risk of greater market pressures from capital outflows and the currency, due to sudden shifts by the US Fed, or moves to strengthen the dollar. Those are both concerns for China’s domestic economy or its asset markets.”

Another downside risk comes from a possible spiking in credit defaults.

The frequency of credit defaults has dropped alongside a decline in both rates and credit-yield curves, said UBS. New primary issuance and secondary trading activity have also revived, but investors remain cautious.

“The ongoing slow downshift in credit and rate-yield curves will continue medium-term.”

That suggests there is room for further downward adjustments before the year-end, but those may be restricted if short-term money market rates continue to be kept at current levels, said the analysts.

“Conversely, a sudden liquidity squeeze or temporary credit crunch could be triggered by an unexpected rise in defaults, or a sudden tightening of regulations,” said Wang.

“The former could arise from the further worsening of issuer asset quality, or SOE restructuring and excess capacity reduction events.”

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