The crisis brewing in China is likely to affect everyone

One of the most worrying economic stories in the world right now is unfolding in China’s real estate sector. To put it in perspective, real estate drives nearly one-third of China’s economic activity, and housing accounts for about 70% of household wealth. Nearly 30% of all bank loans are property-related.

The ripple effects are impacting the entire Chinese economy—it grew only 0.4% in the last quarter compared to the previous year—and may turn contagious around the world.

Here are some numbers. Some 21 major developers have defaulted on their debts in the last year, led by China Evergrande Group, the country’s second-largest real estate company, which has been creaking under $300 billion in liabilities. S&P Global Ratings has warned that around 20% of the Chinese developers it rates are at risk of insolvency.

According to one study, housing sales fell 27% in volume year-on-year between January and June. And it’s getting worse. July sales fell 13% from June and 27% from a year earlier across 100 major Chinese cities. Consultancy firm Capital Economics estimates that about 30 million newly developed properties remained unsold last year, while about 100 million more were likely to have been bought but not occupied. Home prices dropped for the 11th straight month in July. S&P expects property sales to fall by a third in 2022.

And in a sort of popular uprising which seemed unimaginable in a country where the slightest dissent is crushed, hundreds of thousands of citizens are banding together and refusing to repay their home loans on delayed housing projects. ANZ Research estimates that these boycotts could affect about $222 billion of loans.

So, massively leveraged property developers can neither pay their debts nor finish their projects. Millions of Chinese who spent their savings buying property as an investment are finding no buyers. Huge numbers of others have no idea when they will get possession of their properties, even as they carry the burden of mortgages. Banks are being squeezed from both sides—by developers who borrowed and cannot pay up and retail customers who are refusing to. There have been runs on several banks, as citizens tried to withdraw all their deposits following rumours that these banks are broke.

How did it come to this? Over at least two decades, a government policy of ensuring cheap credit for real estate projects built up a giant housing bubble. Beijing encouraged people to buy property by keeping bank deposit interest rates at near-zero levels. Common citizens were left with few other avenues to invest their savings. As is typical of bubbles, developers went on a reckless expansion spree, but were never short of customers, who borrowed heavily in the belief that the prices would keep rising endlessly and they would be able to make a nice pile one day.

The Chinese government had been making regulatory changes since 2017 to rein in runaway prices, but the final blow came in August 2020, when China’s central bank announced a strict “three red lines” policy, imposing limits on the ratios of a developer’s debt to its cash, equity and assets. Almost immediately, the real estate sector went into a tailspin, with a sudden and sharp rise in bond defaults, missed payments and stalled projects.

Matters have been exacerbated by Beijing’s ruthless zero-covid strategy, which has led to repeated long lockdowns, hurting economic growth and people’s incomes, and therefore their savings. Youth unemployment, according to official figures, has reached 20%. And last week, a severe drought and heatwave in Sichuan province, a manufacturing and lithium mining hub, forced the government to order the closure of all factories for six days to ease power shortages. This affects a range of businesses across industries, including companies like Apple, Tesla, Intel and Toyota.

The central bank has injected some fresh money into the Chinese banking system to fight the real estate crisis, but strangely enough put much of the onus on local governments. They have been asked to offer tax rebates and cash subsidies to home buyers and relief funds to developers. But local governments are not in very good shape financially, and a key reason for this, ironically, is the bursting of the country’s real estate bubble. One of their largest sources of income used to be revenue from selling usage rights over state-owned land to developers.

Debt-ridden developers with millions of unsold apartments and hundreds of unfinished projects will hardly be buying more land any time soon. Local governments’ land income dropped 31% year-on-year in the first half of 2022. Extending new concessions to both citizens and developers could have dire consequences for their balance sheets. Beijing has not announced any long-term solutions to these problems.

There are broader issues too. The mortgage boycott movement indicates that common Chinese citizens are now miserable enough to defy ironclad rules. This is a huge development. Xi Jinping is looking to seal an unprecedented third term as president. He will almost certainly get his wish, but perhaps his image of superhuman infallibility has been dented a bit among his people. The truth is that Xi’s harsh policies since the beginning of the pandemic have seriously damaged the world’s second-largest economy. And given China’s key place in the global economy, it may not only be the Chinese who will suffer the effects.

Sandipan Deb is a former editor of ‘Financial Express’, and founder-editor of ‘Open’ and ‘Swarajya’ magazines