Ripple effect of China real estate crisis risks bigger economic blow

China‘s real estate slump has sucked in both banks and provincial governments, threatening a bigger impact on the world’s second-largest economy.

Defaults have soared over the past 12 months after property developers’ debt-fueled growth model lurched into reverse. Including delayed payments, 99 defaults on domestic debt occurred in the year through Aug. 8, 2.2 times as many as a year earlier, according to Shanghai-based Wind Information.

S&P Global Ratings warns that around 20% of Chinese developers it rates are at risk of insolvency.

China’s government triggered this reversal by imposing tougher restrictions in 2021 on mortgages and developers’ access to financing. Lockdowns under China’s zero-COVID policy added to the pressure.

New housing sales shrank 27% on the year in volume in the January-June half. July sales fell 13% from June and 27% from a year earlier across 100 major Chinese cities, according to real estate research company China Index Academy.

Banks have begun to feel the heat. Lending to the real estate sector makes up 26% of China’s total outstanding loans, compared with around 21% to 22% in Japan at the height of the property bubble there. The percentage of nonperforming loans held by China’s big four state-owned banks increased by over 1 percentage point in 2021 to 3.8%.

Unable to secure cash, many developers have halted ongoing condominium construction projects. Nearly 4% of new builds sold in the four years through June 2022 had problems, estimated Yan Yuejin at Shanghai-based E-house China R&D Institute.

This in turn has triggered a mortgage strike, with homebuyers in more than 300 unfinished projects now refusing to make payments. This will have an impact on 900 billion yuan ($133 billion), or 1.7%, of outstanding property debt, Yan said.

In order to stave off instability in the financial sector, China is injecting 320 billion yuan into the banking system this year. Some of these funds are proceeds from local government infrastructure bond offerings that have been redirected toward banks.

Local governments are hardly on solid financial footing themselves.

As tax breaks eat into their revenue, local authorities have come to rely heavily on income from selling usage rights for state-owned land to developers. Land sales revenue exceeded tax income in 2020 for the first time in data going back to 2010.

But cash-strapped developers cannot afford land for new residential properties. Local governments’ land income dropped 31% on the year in the first half of 2022, and is expected to decline on a full-year basis for the first time in seven years. The squeeze on the industry has also hit income from property-related taxes.

This income loss has taken a severe toll. S&P Global estimates that as many as 30% of local governments could be in dire enough financial straits at the end of this year to require corrective action such as spending cuts.

The Chinese government plans to set up a real estate fund of up to 300 billion yuan to help developers access capital, Reuters reports. But “that’s clearly too little,” a Communist Party source said.

Real estate has been a key driver of the Chinese economy in the last two decades. Real estate and related activities now account for around 29% of gross domestic product, up from less than 10% at the end of the 1990, according to Harvard University professor Kenneth Rogoff. This compares with levels of 20% or less in the U.S., Europe and Japan.

Rogoff estimates that a 20% decrease in property-related investments, broadly defined, could dent China’s GDP by 5% to 10%. Real estate and construction account for over 15% of urban employment, creating a potential source of job market instability.

When China suffered a stock market crash in 2015, robust consumer spending helped revive the economy. But consumers today appear more focused on saving in response to a long chill in the job market. With China’s leaders focused on the twice-a-decade Communist Party congress this fall, a major policy intervention looks unlikely in the short term.


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