Lucy Wang finds herself at the sharp end of crisis seeping through China’s property market. She once dreamt that buying an under-construction apartment in the northern city of Zhengzhou would be her ticket to a new life.
For a young woman from a farming village, the Rmb250,000 ($34,839) down payment she used to secure the property represented a big outlay. Half of the money had come from her parents, who had put aside years of meagre savings from selling the potatoes and wheat they grew on the family plot.
Everything seemed set fair until October last year, when building activity on her block of flats suddenly stopped. At first, she said, the developer of the Meiling International House was evasive on when construction might resume. Then its representatives started spouting reams of unlikely excuses.
In July Wang’s hope died. The local housing bureau told her and other buyers that their money had been “misused”. “I have lost faith in the developer,” she said. “This has ruined my life.”
China’s property crash
In a two-part series, the FT looks at how the slump in house prices is causing a sharp slowdown in China’s economy
On Wednesday: can China reinvent its growth model?
Wang is a victim of China’s gathering economic gloom. A property market that has contributed around one quarter of GDP has over the past decade turned sour, triggering a series of secondary effects that are smothering growth in the world’s second-largest economy. Logan Wright, a Hong Kong-based partner at consultancy Rhodium Group, calls the situation a “slow-motion financial crisis”.
Contagion is spreading into the deep tissue of China’s political economy. What began as a property crisis — characterised by slumping apartment sales and a rash of debt defaults by developers — is now morphing into a financial crunch at the local government level.
A new world of difficult choices looms before Chinese policymakers as a crucial congress of the ruling Communist party this month looks set to award another term in office to Xi Jinping, China’s authoritarian ruler.
With the market slump, thousands of local government financing vehicles (LGFVs), which since the financial crisis have provided the main impetus behind China’s investment-driven growth, are either running short of funds or teetering on the brink of unprecedented defaults, analysts say. Local governments have long depended on land sales to property developers to balance their books.
Taken together, the slumping property market, the sputtering investment engines of local governments and a hefty burden of national debt signals the end for a model of growth that has not only transformed China but also been the biggest generator of global economic expansion for well over a decade.
Dan Wang, chief economist at Hang Seng Bank, a Hong Kong-headquartered bank with significant operations in mainland China, says the economy has arrived at an inflection point. “The old model of relying on infrastructure and housing has essentially finished,” she says.
One of the next twists, according to Wright, is likely to be unprecedented defaults by LGFVs on the domestic bonds they issue. If LGFVs do default, it will signal the crossing of a “Rubicon”, he says.
This is partly because these bonds — which have financed the construction of roads, railways, power plants, airports, theme parks and hundreds of other pieces of infrastructure — have been assumed to enjoy an implicit government guarantee. More materially, such defaults could also destabilise a $7.8tn mountain of debts built up by such LGFVs, sending chills through an already cooling economy.
To put it in context, that figure for LGFV debt is the equivalent of nearly half of China’s total GDP in 2021 — or, for example, about twice the size of Germany’s economy.
In the free markets of the west, financial crises can erupt suddenly, taking governments and investors by surprise. But in China’s state-driven economy, infirmities metastasise more slowly as Beijing deploys political and financial capital to battle against the turning tide. This gives proceedings a more stately aura, but it does not mean that underlying problems are any less severe, analysts say.
The global implications of a Chinese economic slowdown are stark. The country’s contribution to the world’s economy, already hit by a sharply slowing GDP growth rate this year, would be further enfeebled. Multinationals that derive much of their revenue growth from China may be forced to trim earnings projections.
“China’s growth model has run its course,” says Chen Zhiwu, professor of finance at the University of Hong Kong. He adds that in the past few years, Beijing has tried to stretch the booms in property and infrastructure in order to prolong investment-led growth.
“But now, all these drivers have little space left, if any at all.”
Three red lines
Wang’s travails reveal a crucial aspect of what is ailing the property market. She had bought a “presale property”, a type of investment that worked satisfactorily when apartment sales were buoyant and real estate prices were almost perpetually on the rise.
Under this model, buyers would hand over a down payment of typically 30 per cent of the value of an apartment. They would then start paying monthly mortgage instalments as the developer built the apartments from the ground up. If everything worked out, the buyer would take delivery of a new apartment on a certain date, happy in the expectation that it would be worth more than when construction began.
But several factors have conspired to undermine this cosy arrangement.
In August 2020, the Chinese government — spooked over the spectre of a debt-fuelled property bubble — imposed “three red lines” on developers to restrict their capacity to add to already giddy levels of debt. This, in turn, left some overleveraged developers without the means to finish apartment blocks they had already pre-sold.
As developer funds dried up, building activity on some apartment blocks petered out. In protest, hundreds of thousands of would-be apartment owners this year boycotted the mortgages they had pledged to pay on more than 300 developments in nearly 100 cities.
Wang was one such protester. She says she stopped paying the Rmb3,800 monthly mortgage instalment in June. In any case, it would have been difficult for her to afford the payments because her job as a sales agent for “baijiu”, an alcoholic drink, has been hit by China’s broader economic slowdown.
“I am not optimistic about the project,” Wang says. “I heard an executive at the developer has recently been arrested.”
Economic contagion
Personal misfortunes such as Wang’s reveal the human cost from a contagion that is starting to course through the main arteries of the Chinese economy.
“The next stage of the property crisis is the transmission of losses from property developers to China’s financial system,” says Wright, tracing a clear line of cause and effect from the current stalled real estate projects to local government debt distress, lower investment levels and finally to the possibility of emergency state bailouts.
Such transmission mechanisms are already in play.
The “three red lines” policy that mothballed the Meiling International House project has clobbered the finances of real estate developers, which together missed payments on a record $31.4bn in offshore dollar bonds by August. Developers are also being hit by collapsing business revenues: official figures show home sales in China fell nearly 30 per cent in the first half of the year to about Rmb6.6tn.
But it is the next link in the chain that is really crucial. As developers ran short of income, they had to slash their land purchases for new projects. Such land sales have long been a lifeline to local governments, accounting for roughly 40 per cent of their recent annual revenues, according to Moody’s, a rating agency. This, in turn, rendered local governments much less able either to drive growth through infrastructure investments or to repay their huge piles of debt.
The potential size of this problem is brought home by the numbers. The decline in local government land sales revenues in the eight months to August was 28.5 per cent year on year or, in monetary terms, down Rmb1.4tn from the same period last year, according to official figures. If that trend is annualised, it will produce a full-year decline of Rmb2.5tn, notes Wright.
Such a shortfall represents more than half of the Rmb4.5tn in LGFV debt that is set to come due before the end of June 2023, according to Wind, a database provider. The upshot is that — absent a big bailout from Beijing — local governments will struggle to honour the debts of at least some of the thousands of LGFVs that they own.
If defaults do occur, analysts say, they risk destabilising the whole stack of LGFV debt, which stood at about Rmb54tn (US$7.8tn) at the end of 2021, according to Wind, a database provider. Following defaults, a flight to safety would probably take hold, driving Chinese financial institutions to shun the bonds of LGFVs from those provinces with weaker financial…
Read More:China’s property crash: ‘a slow-motion financial crisis’
2022-10-04 04:00:57
