A Lehman Brothers moment for China

Belated and wrongly timed government action has created the biggest ever economic crisis for the Communist country

No, it wasn’t an increasingly hostile United States administration, trade sanctions, global inflation, semiconductor ban, or a resurgence of COVID-19 that has hit the Chinese economy the hardest in recent times. Instead, it was the relentless growth of China’s real estate market, which accounts for one-third of the country’s GDP – their ballooning debt threatening to turn into a bubble, a belated and wrongly timed government action that has created the biggest ever economic crisis for this Communist country. The Asian Development Bank cut its growth forecast for China to 4% from an earlier 5% – that’s shaving off US$200 billion from its economy.

The turmoil in Chinese markets has sparked debate among some economists over the possibility of a “balance sheet recession”, a type of economic recession that occurs when high levels of private sector debt cause individuals or companies to collectively focus on saving by paying down debt rather than spending or investing, causing economic growth to slow or decline.

At stake is US$5.2 trillion in debt

However, that’s just the tip of the iceberg. At stake is over US$5.2 trillion (as of June 2021) in debts accumulated by real estate companies, according to financial services company Nomura, According to Refinitiv data, Chinese real estate developers have US$117 billion worth of debt maturing in 2022, with US$36 billion of those denominated in dollars. Moody’s issued nearly 100 downgrades for high-yield Chinese property developers in the last 10 months. Evergrande is China’s leading real estate developer and is presently the most indebted one having a total liability of more than US$300 billion.

The tipping point happened in April this year when depositors were unable to access their money in four rural banks in Henan, an important agricultural base. Since then, many depositors have protested at local banks and government offices.

70% of household wealth locked in property

According to data from HSBC, 90% of urban residents own property, and over 70% of household wealth is tied up in the property. Property is widely seen as one of the most stable forms of investment and a foolproof means of ensuring wealth and security for one’s family. In addition, cultural traditions mean that many young married couples prioritize purchasing a home, with many getting help from family members. The very foundation of this investment by ordinary Chinese is now crumbling.

Right step, wrong timing

President Xi Jinping’s war on property speculators, which kicked off in 2020, was a good idea at a bad time. As with prior attempts, the government has bitten off more than the economy can currently chew. Now buyers are in open revolt and the market is tanking, putting stimulus – and stability – at risk. Capitulation by China’s government looks inevitable.  The crisis was triggered by the country’s largest real estate player Evergrande in late 2021 when the group having US$300 billion in loans defaulted in interest payments, they were hurt by the change in laws on what would be the maximum debt any real estate developer can have. This was the beginning, and being the largest Evergrande was the 1st to bear the brunt. Other developers also started feeling cash strapped, and resorted to many ways like deep discounting, even taking payments in watermelons!

Unable to refinance and facing softening sales, weak developers defaulted on contractors, which stopped building. That prompted irate buyers in multiple cities to threaten to halt mortgage payments for unbuilt properties, a movement that’s hard to suppress. Analysts estimate between 500 and 600 million square metres could be on hold, equivalent to 10 Manhattans. With nearly one-fifth of employment-age youth out of work, Beijing is hurrying fresh infrastructure spending to create quick jobs, but the benefits will be cancelled out if nobody resumes building these incomplete apartments.

Average construction costs per square metre are around 4,000 yuan per official estimates, implying at least 2 trillion yuan (US$300 billion) is needed to deliver the unbuilt projects to their owners, who will then resume making payments to their nervous bankers. Given the problem has been publicly metastasising for a year now; some might wonder why officials haven’t waved their financial wand already.

It’s hard to catch a falling knife

There is no magic wand. First, any rescue bails out entities and people Beijing has been trying to squeeze, namely irresponsible developers and speculators who bought non-existent apartments on credit. This will reinforce the moral hazard Xi has been trying to eradicate. Second, the institutions best positioned to take over the projects and fund their completion – local governments, state developers, banks and government asset managers – are under financial stress themselves due to wider economic malaise. That’s why they have been slow to step in. The central bank, which is still attacking the country’s vast stack of bad corporate debt and has to worry about the capital flight as the dollar surges, has refrained from sharply lowering interest rates to spur growth monetarily.

Finally, it’s hard to catch a falling knife. Funding the existing projects will end the current boycotts but won’t necessarily revive demand in a sliding market that hosts enough empty apartments for 90 million people, per Rhodium Group estimates. As developers’ cash flow woes worsen, they could put yet more projects on hold, requiring yet more intervention.

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