Commentary on Political Economy

Tuesday, 25 January 2022

 China ignited a property implosion. Now it is trying to engineer a soft landing

Stephen Bartholomeusz

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Having ignited an implosion in their property sector last year, China’s authorities now appear to be doing anything and everything they can to put a floor under it.


It was Beijing’s “three red lines” policy last year, which limited property developers’ leverage, that completely destabilised the sector and led to a continuing spate of defaults on developers’ debts, most notoriously the $US300 billion ($419 billion)-plus liabilities of the country’s second-largest developer, Evergrande.


China is responding to the consequences of an attempt to deleverage its economy that was too successful.

China is responding to the consequences of an attempt to deleverage its economy that was too successful. CREDIT: GETTY

That policy was slightly relaxed earlier this month to enable those developers with access to cash or borrowing capacity to buy assets (but not equity) from the raft of major companies with liquidity issues, with the authorities hoping that will help consolidate and stabilise a sector that generates as much as 30 per cent of China’s economic growth.


This year Chinese state-owned companies have become buyers of distressed property assets, apparently at the direction of provincial governments.


There have also been reports that local government financing vehicles are buying property for, and even from, their local governments, which are heavily reliant on revenue from land sales.


The central authorities are planning to give developers’ access to funds from pre-sales that have been held in escrow pending completion of the developments.


Stephen Bartholomeusz

Senior business columnist


Many local governments had frozen withdrawals from those accounts – a major source of funding for developers – after Evergrande’s inability to meet maturing debt obligations threw the entire sector into chaos.


The People’s Bank of China has been cutting key interest rates and pumping liquidity into China’s financial system and made it clear it will continue to do so to ensure economic and financial stability.


More mortgage lending by China’s banks has been “encouraged” and the interest rates on mortgages have been cut for the first time in two years.


The authorities are responding to the consequences of an attempt to deleverage China’s economy that was too successful.


Investment in the property sector grew 4.4 per cent last year, almost half the rate of a year earlier, and was almost 14 per cent lower in the December quarter than the same period of 2020. New construction starts and property sales have slowed and prices for new houses and apartments were starting to fall towards the end of last year.


The People’s Bank of China has been cutting key interest rates and pumping liquidity into China’s financial system and made it clear it will continue to do so to ensure economic and financial stability.

The People’s Bank of China has been cutting key interest rates and pumping liquidity into China’s financial system and made it clear it will continue to do so to ensure economic and financial stability. CREDIT: BLOOMBERG

The developers’ stress is being mainly felt by bond holders, particularly offshore bond holders, although China’s banks had almost $US500 billion of non-performing property-related loans last year according to local media reports.


Suppliers, apartment buyers with deposits tried up in escrow accounts and property investors have also been affected, although the authorities have prioritised their protection.


Beijing is trying to engineer a soft landing for the sector, aiming to end up with a smaller, less leveraged group of stronger entities in a private sector where there is less speculative activity and a bigger role in property for state-owned entities.


It will take more PBOC easings, more SOE and local government involvement and more creditor losses as the most troubled developers are wound up, however, before the sector conforms to the authorities’ aspirations.


The losses for foreign bond holders are likely to be huge.


Despite placatory statements from Evergrande, for instance, some of the holders of its offshored bonds have grouped together and are threatening legal action after saying they’ve had little meaningful engagement with the company other than “vague assurances of intent.” Evergrande has pleaded for more time, asking the creditors to refrain from legal action.


Evergrande, which has been repeatedly defaulting on interest and principal payments, has about $US20 billion of offshore bonds on issue.


Holders of offshore bonds in other major developers have had similar experiences and are equally concerned that the authorities will protect their own constituents in any debt restructurings while disregarding the rights of foreign creditors.


With the National Peoples’ Congress at which Xi Jinping will be confirmed as the Communist Party’s leader for an unprecedented third term looming later this year, the authorities can be expected to adopt a “whatever it takes” approach to stabilising and putting a floor under growth.


The significance of the property sector within China’s economy and the coincidence of its implosion with outbreaks of COVID-19 as China enforces its “zero COVID” approach to the pandemic have hurt overall economic growth.


Growth slowed through last year and, at 4 per cent in the December quarter, was still slowing into the start of this year.


This week the International Monetary Fund cut its forecast for China’s GDP growth this year from the 5.6 per cent growth it forecast in October to 4.8 per cent.


China itself is targeting growth above 5 per cent, which, excluding the big hit from the pandemic in 2020, would be its weakest performance since the 2008 financial crisis. If the IMF is proven right, it would be the weakest in more than 20 years.


The IMF cited the disruption in the property market as a “prelude to a broader slowdown” while also making reference to China’s strict COVID policies.


With the National Peoples’ Congress at which Xi Jinping will be confirmed as the Communist Party’s leader for an unprecedented third term looming later this year, the authorities can be expected to adopt a “whatever it takes” approach to stabilising and putting a floor under growth.


That will have to involve more measures to prevent the distress in the property sector from spiralling completely out of control and to moderate its effects, and those of the COVID lockdowns, on consumers and banks.


The nationalisation of some developers and/or their assets, whether overtly or by stealth, more rate cuts and liquidity and more stimulus for investment that will support the former suppliers to property developers are probable elements in the mix of policies the authorities in Beijing and at local government will have to adopt if they are to control the rapid contraction of the sector.


Stephen Bartholomeusz

Senior business columnist


Those sorts of policies and those required to support Beijing’s tough approach to COVID outbreaks will set China on a very different course to the rest of the world’s major economies, which are responding to surges in inflation rates with tighter, not looser, monetary and fiscal policies.


That policy divergence and the potential for it to trigger massive capital outflows from China and other Asian economies could pose a new threat to China’s stability, which explains why Xi recently urged the West, and the US in particular, not to raise interest rates or shrink liquidity in their systems.

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