Provincial Demographics and Housing Construction

China’s demographic conditions are turning highly adverse to sustaining high rates of economic growth. The rapid decline in birth rates in the past two years has touched off alarm bells in Beijing, with China’s overall population likely to decline this year or next. The 2020 census data released last year were controversial, as they boosted the past decade’s birth rates, but also did little to alter the medium-term demographic trajectory. More surprising have been the revisions of provincial population data. The coming slowdown in the property sector is likely to be concentrated in provinces that are already seeing declining populations, but where credit growth and housing construction have remained strong over the past five years.

Posted April 9, 2022
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Understanding the Risks of Going Local

Foreign investors have increased their exposure to Chinese local government bonds over the past year. But recent cracks in China’s financial system and a shifting geopolitical environment have increased the financial and reputational risks for foreign investors holding these securities. This note analyzes these shifts and their implications. The findings are:

Foreign appetite for local government debt has soared: Global investors increased their holdings to over 11.5 billion yuan ($1.8 bn) by the end of 2021, from 2.5 billion yuan ($362.8 mn) at the end of 2018. Beijing’s liberalization steps have made these securities more accessible, and investors have been drawn by high yields and opportunities to diversify their fixed income portfolios. Yields and trends in foreign holdings of central government debt suggest further growth ahead.

COVID and property market turmoil have increased local financial risks: The property market slowdown and COVID-19 outbreaks are putting pressure on local government finances. The probability of local government bond defaults remains low, but valuation risk is prominent and could be amplified by possible local government financing vehicle (LGFV) bond defaults.

Reputational risks are growing and still underappreciated: Geopolitical tensions have led to a substantial increase in the reputational risks of owning Chinese securities, due to possible ties of companies to forced labor, military-civil fusion, audit non-compliance, and other problematic practices. Our proprietary dataset shows that local government issuers present similar risks, but foreign investors have been slow to recognize them. Links to forced labor and military modernization are the most salient risks for foreign investors.

Reputational risk is quantifiable and manageable: Reputational risk awareness is particularly important for global investors given the low liquidity in local government bond markets and thus limited options to close out problematic positions in the case of a crisis. The good news is that reputational risks remain heavily concentrated in a few areas. Active risk management can help weed out the bad apples, reducing the need for broad-based exclusion of local government bonds from portfolios.

Posted April 7, 2022
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Property Market Chartbook, March 2022

China’s property sector is at a critical juncture, with sales and housing prices now declining sharply, piling financing pressure upon developers. Construction momentum is clearly decelerating and policy support for the sector has been hampered by the resurgence of COVID outbreaks and lockdowns. The announced delay of property tax trials is a small consolation, but it also allows speculators time to exit their positions rather than incentivizing them to return to the market.

Posted March 22, 2022
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