New pain for China’s property sector

This is an audio transcript of the FT News Briefing podcast episode: ‘New pain for China’s property sector’

Sonja Hutson
Good morning from the Financial Times. Today is Thursday, August 17th, and this is your FT News Briefing.

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Inflation in the UK is looking better and WeWork’s junk credit rating is looking worse. Plus, a series of missed payments is causing anxiety about China’s real estate sector.

Thomas Hale
If the real estate sector is failing, what are the spillover effects of that on other areas of the Chinese economy and the Chinese financial system?

Sonja Hutson
I’m Sonja Hutson, in for Marc Filippino. And here’s the news you need to start your day.

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There was a big drop in UK inflation last month. It went from 7.9 per cent in June to 6.8 per cent in July. That was thanks to lower gas and electricity costs. But if you strip out volatile energy and food prices, core inflation still looks pretty concerning. Chris Giles is the FT’s economics editor and he joins me now to discuss. Hey, Chris.

Chris Giles
Hey.

Sonja Hutson
So, Chris, this headline inflation number is good news for the country, but it’s also good news for Prime Minister Rishi Sunak, who has promised that inflation is gonna fall to 5.3 per cent by the end of the year. What are the chances that he can actually meet that target?

Chris Giles
He could certainly meet it, but it’s not looking entirely definite at the moment, I think is what we can say. There was a big fall, as you said, that was almost all about lower energy prices. There’s gonna be another energy price fall pretty definitively in October. But then you have to rely on core inflation or services inflation also moderating to get to the 5.3. And that is not looking so definite because at the moment we’re seeing pretty chunky monthly increases in both core inflation and services inflation. And if that continues, he won’t make it.

Sonja Hutson
Do we have a sense of why core inflation is staying so elevated?

Chris Giles
Yeah, ultimately the UK, more than the eurozone and significantly more than the US, still has a hot labour market. So wages are going up and companies feel they have to get higher revenues to pay those wages. They increase their prices and that sort of feedback loop, we haven’t broken that yet and the economy’s not been weak enough to force that to be broken. And it might therefore mean the Bank of England has to unfortunately make it weak enough so that that inflationary impulse breaks.

Sonja Hutson
Yeah. Tell me a little bit more about what this means for the Bank of England.

Chris Giles
I think alongside the wages report this week, what we know is that the Bank of England has more to do. Now, that doesn’t necessarily mean it’s gonna have to raise rates a lot further, but it might well be that they have to stay higher for longer or certainly higher until we see inflation coming down. So that must make everyone think that the Bank of England has just a little bit more to do than we thought before we have these figures.

Sonja Hutson
So what’s the rationale for the Bank of England keeping rates higher for longer versus raising them more aggressively and then cutting them more quickly?

Chris Giles
You might say that these things would do a similar thing. The interest rates are now, as the bank noted, in restrictive territory. So they are bearing down on the economy, bearing down on spending, on demand. And so it’s really a question of whether the bank thinks it needs to go harder earlier and sort of get some more pain into the system or whether it can afford to wait for longer. I think some people on the bank’s monetary policy committee would think, would minimise the risks of a policy error of doing too much and of seeing something snap in the economy, because that’s clearly a risk. It’s not necessarily a high risk, but you might want to think that now you have got interest rates to a level where you’re pretty sure they are bearing down on economic demand, spending and, ultimately, inflation that you could just sit there for a little bit.

Sonja Hutson
Chris Giles is the FT’s economics editor. Thanks, Chris.

Chris Giles
Thank you.

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Sonja Hutson
The credit rating agency Fitch downgraded WeWork yesterday. The US office space company’s rating is now even further in junk territory. Fitch said the change was because of worse than expected second-quarter earnings. It also pointed to the replacement of several board members with people who have backgrounds in restructuring. WeWork warned last week that there was, quote, “substantial doubt that it would be able to stay in business”. Quite a fall from grace for a company that was once valued at $47bn. It’s now worth just $350mn.

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There’s been a lot of concern over the health of China’s real estate market, and the past week hasn’t helped. Two major companies have missed payments. Here to talk with us about the situation is Tom Hale. He’s the FT’s Shanghai correspondent. Hey, Tom.

Thomas Hale
Hi there.

Sonja Hutson
So, Tom, what’s going on?

Thomas Hale
So the story in China’s real estate market right now and in fact, across the whole of the economy really is the problem of missed payments. We had missed payments on international bonds from Country Garden, which is the biggest private developer in China last week. And this week they’ve had to suspend trading on at least 10 of their bonds because their situation is so bad, they’re really fighting for their survival.

Perhaps more significantly, we’ve also had a growing crisis emerge around a company called Zhongzhi, which is not a real estate company in and of itself. It’s a wealth management company. A part of this group failed to make payments on trust products to companies, and that has really sent waves of anxiety through China over one very simple question, which is: if the real estate sector is failing, what are the spillover effects of that on other areas of the Chinese economy and the Chinese financial system? Zhongzhi, as a major financial conglomerate in China that’s running into very significant difficulties right now, is potentially only the tip of the iceberg.

Sonja Hutson
How exposed is Zhongzhi to the real estate sector? 

Thomas Hale
Well, that’s the crucial question, and that’s the question everyone in China is asking. The actual exact nature of a company like Zhongzhi’s exposure to real estate is very difficult to ascertain because we’re dealing with a very opaque industry, essentially. The only thing I think we can be very certain of is that real estate in China for the last two to three decades has been the core driver of household investment. And that’s one reason why Zhongzhi this week has become this kind of flash point that everyone’s frantically talking about, because the fact that we can’t be certain what’s going on with it is really the core of the problem for investors in China right now.

Sonja Hutson
Tom, how has the government reacted?

Thomas Hale
It’s difficult to say what the government’s stance is, and they haven’t made any very clear statements on either situation. In the case of Country Garden, the government has not yet bailed out any property developers who have failed. So that’s a big question mark over coming weeks. In the case of Zhongzhi, we don’t know yet really what the government’s response is to the situation, whether they’re going to stick to their previous approach and allow this crisis to unfold or whether they’re going to change their mind and embark on what would surely be one of the costliest and most dramatic bailouts in the history of the country if they do go ahead with it.

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Sonja Hutson
Tom Hale is the FT’s Shanghai correspondent. Thanks, Tom.

Thomas Hale
Thank you.

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Sonja Hutson
You can read more on all these stories at FT.com for free when you click the links in our show notes. This has been your daily FT News Briefing. Make sure you check back tomorrow for the latest business news.

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