Is China’s Construction Bubble ready to Burst?

The second bailout of Greece has been in the lime light for the past couple of weeks. While Fitch rating’s Andrew Colquhoun said today that Australian and Korean Banks are the most exposed in Asia to the European debt crisis thanks to our dependence on offshore borrowing, is there another crisis brewing around the corner with bigger implications for Australia?

While Eurozone members are bailing out Greece, its believed the China central government has been bailing out its Local Government Financing Vehicles (LGFV) to the tune of 2-3 trillion yuan.

During the last decade, the Western world, fuelled by easy and abundant credit was spending beyond their means. Household consumption was surging along, and China was in the front seat to capitalise on the moment. However, like many other economies, things turned sour in 2008 with the onset of the Global Financial Crisis (GFC). Exports practically dried up overnight for the manufacturing superpower.

To counter the effects of the GFC, Beijing embarked on a massive 4 trillion yuan economic stimulus program. In addition, local governments were told to spend and they did this via local government created companies known as SOEs (State owned enterprises) or LGFV (Local Government Finance Vehicles). They invested in infrastructure and real estate projects such as empty apartments and office towers built to keep GDP ticking along. The heightened activity of SOEs in the real estate markets along with reduced lending standards helped fuel a massive investment bubble and credit boom in 2009 and 2010. According to the Royal Bank of Scotland (RBS), “Chinese banks grew their loans by 65% since the beginning of 2009 as credit expansion was the centrepiece of China’s stimulus package during the global financial crisis. Much of these loans were channelled to LGFVs as well as the property sector.”

SOEs were bidding up prices to record levels, with Beijing’s residential land price record broken by SOEs twice within 6 hours on the 15th March last year. This caused the banning of 78 SOEs from any further real estate investments by the Assets Supervision and Administration Commission a couple days later. The commission believed 94 of the 127 SOEs had been investing in residential real estate, when real estate wasn’t even their primary business.

By June 2010, there were growing concern about who was funding this spending spree. In the post, China’s chief auditor warns of mounting debt on the 26th June 2010, we reported on Liu Jiayi, head of the National Audit Office who wrote in an annual audit report “The scale is large, and the burden is quite heavy” when referring to SOE debts. According to China’s banking regulator at the time, outstanding loans to local government financing vehicles soared 70 percent in 2009, hitting 7.38 trillion yuan at the end of that year. As infrastructure projects continue to burn cash with little return on investment, Mr Shih suggests China could be in for a “pretty large-scale financial crisis around 2012″ if nothing is done to address the issue.

But, with little ROI and a cooling property market, Beijing has been forced to inject 2-3 trillion yuan into the LGFVs. David Cui of Bank of America-Merrill Lynch Global Research indicates that “LGFV loans are at 10 trillion yuan by the government’s estimate; the ones with no cashflow support”, suggesting a second bailout may not be too far away.

Societe Generale has just released a 50 page report titled “Chinese construction bubble – Preparing for a potential burst.” Using a variety of data (cement consumption, elevators, skyscrapers, roads, railroads etc), it sets about determining if the construction bubble is myth or reality. It believes Chinese construction is ahead of the development curve in a number of areas, but while there is early signs of weakness it can’t find any immediate trigger for a downturn.

According to the report, 60 percent of new elevators manufactured in the world are fitted to buildings in China. The number installed has grown substantially from 10,000 in 1990 to more than 300,000 in 2010, representing a compound growth rate of 20% that “looks unsustainable in the mid-term”. Consumption of cement by China in 2010 exceeded 1,800 million tonnes, accounting for 55% of world demand. Average consumption per head is 1,400kg, four and a half times about the average ex-China consumption of 300kg.

Societe Generale then turns to figures on the delivery of excavators, loaders and bulldozers from the China Construction Machinery Association (CCMA). While demand has been strong up to March, deliveries are starting to fall. Excavators sales are down 65% for the month of May and down 12% over the year. It also reports “In addition, the sales volume of loaders and bulldozers also saw sharp drops May, with that of loaders falling 45% from March, the largest drop since 2001.” It believes a reason for the decline could be from financing constraints.

Fitch’s Senior Director of Financial Institutions, Charlene Chu, told Bloomberg today “We are pretty concerned about a big problem with bad debt over the next few years associated with local governments, property and all of the excesses that have been built up since the stimulus of 2008”.

“If we have a downturn in the Chinese property market it would have a significant impact on the banking sector,”

» Exclusive: China to clean up billions worth of local debt – 31st May, 2011.
» Fitch Says China Property Downturn Would Significantly Impact Banks – 23rd June, 2011.
» Banning SOE Real Estate Investment to Impact the Soaring Price of Housing: An Analysis – The Epoch Times, 23rd March 2010.
» 5 Things You Need To Realize About China’s Gigantic Bailout Of Local Governments – Business Insider, 2nd June 2011.
» Fitch flags credit-risk worry at China banks – Market Watch, 22nd June 2011.


  1. Hmm, I can see a slow down in demand for Minerals but I can’t see the tap being turned off. Even if China does have a Property Crash it’s fairly obvious that there will still be demand for Australia’s resources to feed China’s Sweatshop Factories that as we all know make just about every manufactured item known to man.

  2. AverageBloke, at the moment 50% of revenue from resources comes to Australia. The other 50% of revenue belong to interests other than Australian. The 50% that comes here, 25% comes to Australian inverstors in the form of dividends or SuperFund investments, and 25% comes to the Government from taxation. The Australian Government wants a bigger cut of that pie, why? Certainly not for the sake of fairness or any moral reason (not condecending you saying that, I’ve just become far too overly-hyper-cynical with no return). They need more money, we (as individuals) need more money, things aren’t good.

    OK 50% doesn’t come here, 25% to specific investors or investment instruments here, then there’s the mines that are owned by China or other foreign consortiums, and 25% is taxation for the Australian Government. And these resources are ours? Include the royalties for the resources (coins in a tin can, exaggeration!) with the tax, and (to me) it doesn’t look like we’re on the ownership side of the fence. More like “here’s your cut” side of the fence.

    8.4% of GDP and less than 2% of the workforce knock on will save us or keep things as they are? Regarding property that is. Are we looking at mining and resource sales claiming property will remain at least stable? Maybe (I hope it will). Are we that property neurotic that we’re looking for property saviours, and can’t look at property itself, or other parts of the economy to say or see that things will be OK? Man! this China story we keep hearing is begining to look a bit dull to me.

    I’m not being argumentative with you AverageBloke (well I am a bit) nor singling you out. When the RBA + Treasury are looking at China and exclaiming FutureBoom! It scares me more than eases me like this is what we are hoping for. China can press a few buttons here and there, pull a leaver here, push one there, and if the combination is right, we’ll boom! Don’t know, don’t know.

    The amount of private debt here I reckon can even dampen the Mother of all Booms.

    Also I’m not just asking you these questions specifically AverageBloke its’ for the forum too. Either my intuition is on the right path, or someone has to set me straight.

  3. I agree with what you are saying Botrot. But I still reckon that the default demand from China (and India) that I was talking about will keep the Economy on life-support.

  4. Trouble I see is this will hit at the same time than our housing bubble pops. You will want more than life support when the “commodities super cycle” goes back to sustainable levels, and household consumption falls over a clift due to our domestic debt bubble.

  5. Tom is spot on the money, the trouble is it looks like this could be about to happen if the USA hits the wall again like it seems is on the cards because Europe and the US still buy most of the crap China make and last time China just stock piled stuff untill the US started pumping cash into its econ but this time it will not work and China will start to crash as well. Then Aust will be in the poop up to its ears.

  6. Yes agree with the above. Leaving that aside the euro will fail and when it does and it will !!
    This will bring another GFC along, but greater. No this is not a guess this is predicted through basic economics.
    Lending to that which cannot pay back plus the passion of the people not wanting to let go of there lifestyle,.
    will bring this all on.
    Further the euro was established to form a unity of the old roman empire. Many have tried to bring it together, Hitler for one, but have failed.

    You say this can’t happen, well watch europe will disband,it is simply a case of bad economics and repeated history.

  7. Forget China for now it is a drop in the ocean compared to the euro. Yes China will slow not bust euro goes so
    does everyone else. Mind you when it slows all connected nations will feel it.

  8. How reliable are any statistics that come from authorities in China? In fact how reliable are Australian statistics? The ball can be spun many ways. I love GDP figures coming out of China two weeks post quarter. Accurate ????
    The Chinese can knock down and rebuild until the cows comes home to keep demand going strong.
    Debt is only taking future earnings and consuming in the present. The Chinese could keep the game going for many years yet.

    Yoda say – “There are no markets anymore! Only interventions.”

    Perhaps Bernie Maddoff’s assertion that the stockmarket is just a Ponzi scheme holds a fair bit of truth. He would know.

  9. Yoda, China has just officially released the level of debt held by Local Governments for the first time. While it’s “official” and better than market guesses, its still questionable how much is left off balance sheets

    At the end of 2010, Local Government Debt was 10.72 trillion yuan ($1.65 trillion).
    Local governments are obliged to pay back 62.6% of the total figure, or about 6.71 trillion yuan.
    About 21.8% of the sum, or 2.34 trillion yuan, is guaranteed by local governments.
    15.6%, or 1.67 trillion yuan, involves debt that the governments may be required to pay.

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