Despite optimism for China’s economy returning, as increased exports help mitigate the financial burden of an overleveraged property sector, the critical stakes of China’s ongoing real estate crisis should not be forgotten.
Spain had similar structural problems prior to the 2008 crash. Over time, the country’s entire financial system was made vulnerable to the real estate and development sectors through the granting of excessive credit, which in 2007 accounted for almost 45% of GDP. In 2023, China is similarly exposed as loans to its property sector equaled nearly 42% of GDP, but on a much larger scale with $7.3 trillion in liabilities.
As a result of this exposure, the 2008 crash began a prolonged and traumatic period of financial turmoil in Spain, as the crash was transmitted from property into Spain’s banking system. In 2009, when much of the global economy was rebuilding, Spain’s GDP fell 6.3%. Unemployment had increased by 11.8% by 2010, far more than the euro zone’s 2.6%. It was arguably only after the EU intervened in 2012 that the country’s financial system recovered.
A similar structural imbalance prevailed in China in the decade following 2008, as excessive levels of investment compared to consumption in the development sector fueled the increase of debt to unsustainable limits. This period effectively ended in August 2020, when Xi Jinping reigned in developers with the “Three Red Lines” policy, which limited debt to 70% of a firm’s asset value.
Since then, we have seen the effects of this imbalance revealed in widespread defaults across the real estate and development sectors. Two-thirds of the 50 firms with the most dollar-denominated bonds in Hong Kong defaulted on interest payments after 2020, according to Bloomberg.
So, despite the disclosure of surprisingly strong growth this quarter, there remains a risk that, like in Spain, the ongoing property crisis transmits to China’s banking sector more broadly.
“Unresolved debt from the property sector and local governments poses a risk to the banking sector,” says Darson Chiu (邱達生), a research fellow at the Taiwan Institute of Economic Research. “Local government debt, which is projected to peak by 2030, could trigger a domestic financial crisis.”
China’s local authorities will be among those feeling the squeeze the worst, as land sales for development historically provided up to 40% of their income. Paying the interest on their exorbitant debts, which as of 2022 reached $12.58 trillion, or 76% of China’s economic output, is now much harder.
Evidence suggests that a domino effect is already happening, as in October 2023 central banks were reportedly told to roll over local government debt at lower rates and with longer terms. Last month banks were told to speed up the pace of borrowing to private developers, as Beijing intervenes to try and restore growth.
“In the background of all of this is a change in belief and a loss of confidence, both domestically and abroad in the Chinese economy. Belief is very important, especially for the real estate market, which relies on high levels of speculation. This loss of confidence is self-fulfilling and will cause prolonged stagnation,” says a research fellow, who wished to remain anonymous due to ongoing work in Hong Kong, at Academia Sinica’s Institute of Economics.
The numbers reflect this. Since 2020, real estate sales have dropped by 50%, according to the IMF. Country Garden, once seen as a safe bet, has seen its sales fall by 81%. The National Bureau of Statistics reports that consumer confidence fell more than 30% in the first half of 2022. In the third quarter of 2023, more foreign money flowed out of China than for the first time since records began in 1998.
“Despite this, I think a financial crisis is unlikely. Most major banks in China are state-owned,” the professor from Academia Sinica explains. “The government will continue to bail them out.”
Official estimates give a sense of the staggering scale of the development sector’s imbalances. Vacant homes in China could house the entirety of its 1.4 billion population with some to spare, according to the former deputy head of the National Statistics Bureau. Borrowing and building ahead of demand produced some 648 square kilometers of unsold floorspace by the end of August 2023, the National Bureau of Statistics reported.
Much of Western media’s coverage of Chinese development practice indulges in awe and schadenfreude at the swathes of unfinished and partially inhabited apartment blocks that are common in China’s second and third-tier cities.
But the huge amount of excess stock is partly explained by the fact that investing in property is a main way for Chinese people, whose options are limited by the government, to invest their money. In August 2021, housing assets accounted for an enormous 62% of gross household wealth.
As such, house prices decreasing for the ninth consecutive month in March could have an outsized effect on Chinese people’s economic outlook, explaining weak consumption in 2023.
This excess of stock is also caused by price controls. If the Chinese property market were free, then the excess stock would be counterbalanced by lower prices. In China, however, price supports have historically been used to prevent decreases in demand and supercharge growth. This is one reason why prices haven’t fallen further despite a dramatic drop in new starts and sales, according to the IMF.
Despite the extraordinary phenomenon of vacant and unfinished homes, and the likelihood of stagnation, the economic outlook for China is not all bleak. Several banks recast their predictions for China’s growth this year in the middle of this month, as the country released strong growth in the first quarter of the year, driven by strong industrial exports.
Despite this, the IMF predicts that real estate investment will fall by almost 45% and will stay low for the next few years. A financial crisis may be unlikely, but the financial burden caused by the unresolved debt of developers and local authorities is not going away, and may continue to dampen consumer confidence and speculation across the domestic economy.
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