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Highlights
- The overheated Chinese economy is showing red flags in the property sector.
- China's largest property group, the Evergrande group, is neck-deep in a financial mess.
- Stakeholders are watching how Australia will come out of the combined challenge of the Delta variant and headwinds in its primary export product i.e. iron ore.
No market is devoid of volatility, and neither is the market for metals. Since their peak in May, iron ore prices have plunged almost 40%. There indeed is reason for Australia quaking in its boots. As per Minerals Council of Australia, in 2020, iron ore shipments from Australia increased by 31 million tonnes and totalled 867 million tonnes of which China represents a key export market for Australia, accounting for almost 80% of Australia’s iron ore exports (by volume). What is worrisome is the headwinds with the Chinese economy.
Headwind named Evergrande in the Chinese economy
Since the start of 2021, China's largest property group China Evergrande has been struggling to secure funds to survive. The company expanded massively by borrowing and now has a debt of over US$300 billion. The company is sending jitters for all the players in the sector as investors are desperate to salvage their sinking ships. Last year, the government introduced new rules to control the real estate developers' escalating debt levels. Following this, Evergrande gave heavy discounts to keep the business running. Now it is neck-deep in a mess with interest payment obligation, tumbling share prices and downgrading by credit rating agencies at the global level. The real estate developer will make a massive US$84 million in interest on its bonds tomorrow.
The company is doing its best to sell assets and refinance as stakeholders like contractors, creditors and apartment owners fret. The panic is escalating because Evergrande must sell off its apartments further at a heavy discount- a major reason behind the property bubble that is now bothering the country. So it is worth tracking what the climax would be.
Some industry experts see a Lehman in the making in China with Evergrande in the doldrums. However, others are of the opinion that the default levels aren't as substantial relative to the size of the Chinese economy. However, in a letter to staff on Tuesday, the company chairman showed reassuring confidence that it will wade through this dark moment. Still, investors fear being on the runway to a massive failure.
Related Reads: Evergrande woes resonate in Wall Street: Dow, S&P futures in red
Image Source: © Ironjohn | Megapixl.com
Chinese development invited the bubble
The once agrarian economy, China transformed itself over 40 years, mainly with the development of infrastructure. Building constructions stimulated economic growth. On the other hand, real estate speculation went too high. Poor construction standards and loopholes in lending were additional illegal activities mushrooming around the sector.
What is now happening on the property side of the Chinese economy is typical of an overheated economy. There was excessive production of infrastructure in the economy as part of the government’s capital expenditures. Finally, the euphoria around ownership rights over property led to high inflation in property prices and is looking like a forerunner to a downswing.
Reason for worry
In the last five years, Chinese production of crude steel has grown 30%. The demand-supply gap contributed to the soaring prices of iron- ore recorded earlier this year. The steel industry kept pacing forward owing to inventory glitches and strong demand running parallel.
Australia has a string attached to the Chinese market. In 2020 when Australia maintained its acing iron ore exports, China was the world's largest iron ore importer, accounting for 75.4% of the global import volume. One of the primary usages of iron is steel production. Over 95% of the extracted iron ore is diverted towards steel making. Steel is a highly used metal alloy used in construction, shipbuilding, infrastructure development and car making.
We have already stated above that, as per Minerals Council of Australia, China accounts for almost 80% of Australia’s iron ore exports. Hence, the iron ore sector of Australia has the possibility of being adversely impacted by the moves in the Chinese steel sector. In the 75th session of the UN General Assembly, President Xi Jinping stated that China aims to have CO2 emissions peak before 2030 and attain carbon neutrality before 2060.
The steel sector makes the highest contribution to pollution in China, with 10 to 20% of the total carbon emissions coming from here.
In alignment with its carbon neutrality goal, the country seeks to bring down crude steel output in 2021. However, the challenge is that in the last five years, the country, even after cutting down 150 million tonnes of capacity and 140 million tonnes of low-grade steel, has still set records in steel output with a whopping 1.065 billion tonnes last year. That said, any decline in steel production can reduce China's imports of Australian iron ore, which is a core raw material in the production process.
The impacts of Evergrande are setting tremors in the property sector, which too is a significant user of steel. Both these factors taken together could be forerunners of the havoc in the iron ore sector of Australia.
Must watch: ASX rises post a dull start; reacts to Evergrande News
Bottom Line
The Delta variant is putting pressure on the Australian GDP numbers already. Experts opine that the economy would start opening up only towards the fag end of the year. It would be interesting to see how the pandemic, along with the challenges to its key exports of iron ore, would unfold for Australia.
