The story so far: China, the world’s second-largest economy, is facing a crisis in its once-booming property sector. Its Central Bank, the People's Bank of China (PBOC) last week made its biggest recorded cut in the five-year Loan Prime Rate (LPR) to rein in the said crisis. The five-year LPR, which was cut by 1.5 percentage points to around 4.2 per cent, would bring down the cost of housing mortgage repayments across China.
Meanwhile, July data from China’s National Bureau of Statistics (NBS) showed that property investment fell in the country by over 12 per cent year-on-year, the steepest fall this year, per a Reuters report. The start ofnew construction by floor area fell by around 45 per cent, the biggest fall in almost a decade.
What is happening in China’s property sector?
Statistical estimates from America’s National Bureau of Economic Research indicate that real estate, including allied activities, contributes as much as 29 per cent to China’s GDP and has been a key driver of its sustained economic growth. Besides, around 70 per cent of household wealth in China is stored in property.
Since early this year, however, thousands of home buyers have stopped paying their mortgages in protest of unfinished residential projects. These young people or families, who had been paying monthly mortgages at rates of 5 per cent and above, have either stopped or are threatening to stop paying their mortgages in over 300 unfinished housing projects in around 90 cities across China, according to crowd-sourced estimates quoted by The New York Times.
Under a popular way of buying property in China, called “pre-sales”, buyers pay for the property before it is built. According to the BBC, which quoted Julian Evans-Pritchard, a China economist at Capital Economics, “pre-sales” constitute 70-80 per cent of new housing sales in China. Developers often buy land, get loans on it to start construction, and then secure money from home buyers in pre-sales, alsousing those funds to fund other projects.
Home buyers who have gone on mortgage strikes believe that their money has been misused by property developers. Normally, home buyers deposit their money before the project is built in an account monitored by local authorities and banks, meaning developers are not supposed to have access to all the money at once but at fixed stages of construction. With projects remaining unfinished beyond stipulated timelines, many home buyers have resorted to living in incomplete homes.
According to ANZ financial services, these mortgage strikes could impact 1.5 trillion yuan or $222 billion worth of mortgages linked to apartments that risk remaining unfinished. This accounts for nearly 4 per cent of outstanding mortgages. Surveys published by various firms indicated that mortgages at risk of defaulting could amount between $150 billion to $370 billion.
Property sales in China have fallen for 11 consecutive months and the mortgage boycotts have led to weak sentiment in the real estate sector with sales plunging further in July. According to China Real Estate Information Corporation, combined contract sales fell by 39 per cent from last year. April, when property sales by value dropped 46 per cent from last year, posted the sharpest fall since 2006, according to Reuters. It also noted the drop in bank loans now accessible to developers— loans granted to developers by domestic banks dropped 36.8 per cent for July.
The boycotts and sale downturn have left many of China’s big private developers cash stapped, which Goldman Sachs estimating that a third of the developers will default on their loans this year.
What led to the property crisis?
The growth pattern
In a paper for the Carnegie Endowment, Beijing-based economist Michael Pettis writes that over the past decades, the Chinese government has set a GDP target, which local governments, the property sector, and other sectors like investment and manufacturing have had to meet through delivering enough economic activity. Filling this gap was easy during the period from the late 1970s to the 2000s when the economy opened up and there was underinvestment in various sectors, meaning the economic activity delivered was largely productive. Mr. Pettis notes that more than a decade ago, the gap between the investment China had and the investment its economy could constructively absorb was mostly filled, which is when measures to bring down production and reshape the economy to widen consumption should have been taken.
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As the real estate sector- which contributed in part to China’s race to growth- boomed over the past three decades, so did its debt levels. While that was sustainable till demand was booming, the recent bursting of the housing bubble, which analysts have been predicting since 2014, has been marked by plunging demand.
The impacts of the pandemic
The lowered consumption was also compounded by the effect of the pandemic on China’s economy and its stringent Zero-COVID strategy, which restricted businesses and movement, also impacting household savings and investment. Youth unemployment in China reached record high levels and the economy is on its slowest growth path in decades.
2020 policy for developers
Chinese authorities over the years did take some measures but were reluctant to take more extreme steps to reduce debt, worried primarily about the impact on GDP growth.
That changed last year, with President Xi Jinping’s government introducing the toughest measures yet. The central bank put in place what it called the “three red lines” regulation, which categorises property developers based on how much debt they hold and based on this, the amount they could potentially borrow.
Notably, by late last year, 20 of China’s top 30 property firms by sales had breached at least one of three debt red lines set down by the Beijing government to rein in real estate speculation, according to Bloomberg News. Over 60 per cent of China’s developers are estimated to have hit at least one of the three debt thresholds.
Fall of Evergrande
The snowballing of the current housing crisis can be traced back to the 2021 fall of China’s second-largest real estate developer in terms of total sales— the Evergrande Group. The conglomerate breached all three debt thresholds in the red lines system and defaulted on its whopping $300 billion debt. The company had taken money in advance from over 1.5 million property buyers, promising to deliver developed properties to them in the future and had not paid many suppliers. After this, many proverbial skeletons began to roll out of the closet in the form of other big developers defaulting on loans and having unfinished projects.
Local land politics
Dexter Roberts, the author of The Myth of Chinese Capitalism and a senior fellow at the Atlantic Council, told The Hindu last year that the distinguishing factor of China’s real estate sector is the unique politics behind its growth model. Local governments in China are highly reliant on land sales for revenues, which account for, by some estimates, half of the local revenues, needed for everything from infrastructure projects to social welfare. “This means that they need to continually develop new commercial and residential real estate in order to continue to make enough local revenues to run the government,” he said. This model explains how China’s real estate sector — and key players like Evergrande — grew so big, and grew so big so quickly.
What will be the impact of China’s property crisis?
Experts say that while the bigger Chinese banks might be able to manage the mortgage defaults, it might be tough for smaller or rural banks. State-owned Agricultural Bank of China Ltd. said it held 660 million yuan of overdue loans on unfinished homes, while smaller rival Industrial Bank Company said 1.6 billion yuan of mortgages were impacted, of which 384 million yuan have become delinquent. Besides, Chinese home buyers pay a much higher proportion of down payment (around 40 per cent) than those in countries like the U.S., so the property price drops and defaults would have a relatively less adverse impact.
Tertiary sectors allied to property, however, have been impacted. The slowdown in construction is hurting the demand for building materials. Iron ore slumped more than 8 per cent in July, falling below $100 a ton for the first time since December. Futures for steel rebar in construction also collapsed in Shanghai to their weakest since 2020.
According to The Financial Times, China recently gave $148 billion in loans to aid failing property developers. Home buyers could also be given temporary mortgage holidays without reflecting badly on their credit score.But the BBC quoted an Oxford Economics note which said that this could be detrimental in the long run as the financial sector was being forced to help an unproductive property sector stay afloat. China’s regulator, the China Banking and Insurance Regulatory Commission (CBIRC), is also probing banks to gauge their exposure to developers and whether loans were provided as per rules.
In fact, the reluctance of some financiers to help the sector has already been seen in practice; Reuters reported on August 25 that some state-backed financial institutions were not so keen on Beijing’s calls to help the crisis-hit property sector owing to how it might impact their balance sheets.
Besides, experts note that recovery would only be partial and temporary, even if the housing market revives next year when the zero-COVID policy eases. Property prices would continue to decline in the meantime, and insolvencies would continue to spring up until the systemic problems in the sector areaddressed.
As for the international impact of the bubble’s bursting, China’s closed capital account policy isolates it from the global financial markets, meaning a 2008 Lehman Brothers situation is unlikely, experts say.