Persistent problems for the Chinese real estate sector
The problems of the Chinese real estate market, highlighted by the failure of Evergrande, the country’s second real estate developer and its most indebted, continue to worsen, setting in motion what comment in the Financial Time (FT) qualified as a “slow-moving financial crisis”.
The Shanghai Stock Exchange last Thursday suspended trading in three renminbi-denominated bonds of property developer Shimao after failing to make a payment. The suspension was important because, until recently, it had an investment grade rating.
In its report on the suspension, the FT said that Shimao’s problems suggested that “China’s real estate problems, which mainly affected companies with riskier credit ratings such as Evergrande and Kaisa Group, may turn out to be expand to higher-rated developers as they grapple with a slump in home sales and a loss of investor confidence.
Unlike Evergrande, whose affairs are now under the control of a government-appointed risk committee, Shimao had not violated any of the “three red lines” on credit and borrowing imposed by the financial authorities in August 2020 in order to reduce inflated debt levels in the real estate industry.
But the company was strongly impacted by the general decline in the real estate market. Based in Shanghai, it saw a 10% drop in sales in 2021, with December sales dropping 68%.
Last month, the international rating agency Fitch said Shimao was facing a “drop in investor confidence” that could affect its ability to refinance itself and, unlike other real estate developers who had resumed issuing bonds. debt securities, this possibility may not be available to him.
While the immediate problems surrounding Evergrande appear to have been contained, at least for now, the effects of the decline in the real estate sector are rippling through the border economy.
It is estimated that the Chinese real estate sector accounts for around 30% of the country’s economic output once the spillover effects are taken into account. Local governments, which are responsible for much of the country’s infrastructure development, are strongly affected as it has been calculated that about a third of the money needed for such projects comes from the sale of land.
They now face additional problems as the central government has insisted that they are responsible for completing prepaid housing projects if developers are unable to do so under conditions where their income is declining.
The problems facing local governments were highlighted by comments to the FT by an anonymous city official in Shijiazhuang, the capital of Hebei Province, who said the real estate downturn had had a “huge impact.” tribute ”on the local economy.
“Beijing says we have to keep the government operational. But if land sales continue to weaken, it will be very difficult for us to make ends meet, ”the official said. Land sales in the city are down nearly 30% from the same period last year.
Longtime Chinese analyst Eswar Prasad pointed to growing problems for the central government as it tries to move away from reliance on real estate development.
In comments reported by the FT, he said: “Beijing is discovering the enormous costs associated with correcting imbalances in a sector it has long relied on to support growth, increase local government revenues and contribute to l accumulation of household wealth.
“The sector’s influence on virtually every aspect of the economy, financial markets and society makes it an extremely difficult problem to resolve. “
In addition to the immediate fallout from the inability of real estate companies to honor their debts, there is the potential for a financial crisis resulting from the practice of companies issuing commercial paper (short-term debt securities) to bypass the restrictions of the “line. Red”.
Large companies are forcing small contractors and suppliers to accept commercial paper instead of cash payments. These companies then use the commercial paper to fund their own transactions, creating the conditions for a chain reaction if the large company fails to meet its cash flow obligations.
According to the Shanghai Commercial Paper Exchange, China’s top 20 real estate companies issued 40% more commercial paper in 2020 than in 2019.
The FT quoted an anonymous government policy adviser as saying that despite assurances about the state of the economy, there was growing nervousness in official circles.
“They seem more relaxed than they actually are. In the private sector, they wonder about the slowdown in real estate, high debt levels and slowing growth. The major issues are all interconnected: debt, local government finances and consumption. Which do you solve first? The pressure is coming from several directions.
The problems for the economy as a whole are indicated by the latest gross domestic product (GDP) data. In the third quarter, the Chinese economy grew 4.9% year-on-year, compared to 7.9% in the second. And the pace of growth is slowing down. On a quarterly basis, the economy grew only 0.2% from the previous three months.
For many years, the central government maintained that a growth rate of around 8% was necessary to maintain “social stability”. Those days are now over and it looks like, in the words of one financial analyst, a 6-7% growth rate is also “forever” as the government struggles to maintain a 5% target.
The current trend will continue in the longer term. According to an analysis by Houze Song of the Paulson Institute, even without the Evergrande crisis, the real estate industry was doomed to contract and Evergrande “just made the writing on the wall clearer.”
“Our baseline scenario assumes a 30% drop in private property construction through 2025. In terms of total construction volume, that means a correction from 100 million units to around 70 million units. Such a correction will cause annual real estate sales to fall by 15-10% of GDP, which is basically the same as in 2010. In other words, China intends to roll back the decade of rapid growth in the country. real estate sector over the next five years. “
As a result, local government spending on infrastructure, which largely depends on income from land sales, is expected to decline by 3% of GDP over the same period, which, combined with the decline in development. real estate, will lead to an overall decline in construction investment decline of 6% of GDP.
Song noted that over the years, the Chinese real estate industry has been prone to “the boy who cried wolf syndrome,” but this time the wolf has finally arrived, citing the recent remarks by Guo Shuqing, chairman of the China Banking and Insurance Regulatory Commission said property was the greatest danger to the country’s financial system.
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