The world is turning its attention to China’s economy and Korea is taking note. The South Korean Ministry of Finance put together an all-government task force to respond to the potential negative effects of the downfall of China’s largest property developer, Evergrande, which recently cancelled the restructuring of more than $19 billion of debt affecting its international bonds. Accompanied by a worrying swath of trade data concerning the Middle Kingdom, it points to uncertainty about China’s financial state and the possibility of a contagion risk from China’s real estate sector, which constitutes up to 25 to 30 percent of its GDP.
But would it go so far as to affect markets in South Korea? Analysts note that a spillover effect in the event of a crisis is limited. So far, the effects of the Evergrande crisis on Korea remain mostly psychological and would be contained to fluctuations in confidence on the KOSPI index. Korea’s Finance Minister Choo Kyung-ho stated publicly that he expects “no direct impact” on Korea’s economy from the crisis. Evergrande’s debt is denominated in Chinese renminbi, and it is not tied to mortgage-backed securities derivatives the way U.S. mortgages were before the United States’ own 2008 meltdown. The biggest issues so far would be for Korea-China trade as well as the overseas holders of Evergrande bonds and other holders of Evergrande’s $22.7 billion in offshore debt.
Korea’s finance ministry indicated that Korean banks’ exposure to the Chinese real estate crisis is roughly $297 million. A Chinese economic catastrophe would do more harm to the trade relationship. South Korean exports to China are down. China accounts for roughly 23 percent of Korean exports and a reduced appetite from weakened Chinese consumers would hamper the already diminishing trade between the two countries. Korea had until recently benefitted from a large trade surplus of trading goods to China, which has in the past year presented as a deficit due in part to a decline in the export of intermediate goods. Sectors where Korea usually benefits from Chinese demand are seeing the effects of this downturn. Memory chip exports to China are falling, as are electronics as a whole. This is mirrored by Taiwan also experiencing the effects of a down Chinese market.
Other sectors are equally gloomy. China has stopped publishing youth unemployment data. In August, real estate sales were down 34 percent year-over-year. But the pièce de résistance remains Evergrande, which defaulted on its debt in 2021 and lost 79 percent of its market value on August 28 after it began trading shares again after an 18 month pause. Kasia, Fantasia, and Shimao Group were other real estate companies in China which defaulted on their debt, and on October 10, developer Country Garden announced it is expecting to miss upcoming payments on overseas debt. All come after crackdowns by China’s government on excessive borrowing.
Excessive borrowing was targeted by the government to rein in the highly indebted real estate sector. China’s “three red lines” policy sought to limit it by placing standards on excess liabilities, net debt, and cash reserves. Local government financing vehicles (LGFVs), which hold debt levels at 42 percent of GDP, filled the role that private property developers had in land auction markets and accordingly were able to shirk the debt limits set in place by the three red lines. Across China, local governments additionally relied on land-sale revenues to finance infrastructure projects and fund their budgets. The tie-in that real estate has with China’s public debt accordingly has risks for local governments in the event of a crisis.
Prior to curbs on debt, developers rushed to cash in on the waves caused by the appetite for real estate. The trend of housing investments replacing the role of traditional financial products went so far as to lead Xi Jinping to declare at the 19th Party Congress that “houses are for living in, not for speculation”, a phrase which has since been removed from the wording in Politburo policy readouts on the property sector.
Some worry of a “Japanification” of China as a result of declining property values and poor economic outlook. Dr. Zoe Liu and Daniel Stemp point out that the ratio between real estate and mortgage loans that constitute Chinese households’ total assets mirror what they were in the United States before its own property crash, or in Japan before the 1980s financial crisis. Chinese household debt as a proportion of disposable income is equally hitting pre-recession U.S. levels at 110 percent. The real estate industry and its associated activities constituting nearly as high as percent of China’s GDP as it did in the United States creates substantial exposure for the Chinese economy in the event of a 2008 level collapse. Economist Kenneth Rogoff goes so far as to argue that China’s property crisis may be part of a broader “debt supercycle” which has been spreading among low and lower-middle income countries since 2008.
A real estate collapse in China may provide validation for the views of “de-couplers” who push for an exit from the Chinese economy. Nonetheless, some are still bullish. There are still investors who will continue to bet on China’s low cost of manufacturing and advantages from a weakening American dollar. And as it stands so far, it appears unlikely that difficulties in China’s real estate sector would drastically affect Korea’s economy.
The Korean government is right to closely watch the situation unfold. In whatever way it plays out, it will have a ripple effect, if even psychological, for the broader global economy. Even though the Chinese Communist Party may have more levers to pull to stabilize the economy than the United States did in its own financial crisis, it will still have to grapple with restoring the confidence of its investors to return to any form of steady state. Whatever the outcome of the crisis may be, one thing is for certain. The world is watching China for whatever happens next.
Tom Ramage is an Economic Policy Analyst at the Korea Economic Institute of America. The views expressed here are the author’s alone.
Photo from Wikimedia Commons