Building stress

China's real estate sector totters on the brink

The importance of China’s real estate market to the global economy can hardly be overstated. Measured in financial terms, it is according to many estimates the largest asset class in the world, worth over $60 trillion. Swings in the market determine the global price of commodities from steel to cement. And it is intimately linked to the financing of local government in China and, therefore, to the country’s overall balance sheet. Last year, when the aggressive property developer Evergrande began defaulting on loan payments, observers began to understand that the market was facing a crisis; those defaults have now reached their natural next stage of loan restructuring, signalled by Evergrande filing for Chapter 15 protection in the United States while it tries to reorganise its debt. More worrying is that one of its larger – and more reputable – peers, Country Garden, has also begun defaulting on some of its loans even though it has a much lower debt burden than Evergrande, and has more assets than liabilities. Country Garden probably worries that a drop in the value of the assets – built and unbuilt houses – in its portfolio could reverse that equation, and may be moving quickly to control any possible damage.

While China’s real estate sector – with access to land tightly controlled by local governments – has been a solid source of growth for the economy and income for the state, it is likely that the artificial constraints on land in the country have exacerbated house price inflation for decades. But cooling down real estate markets is tricky, and there is little doubt that the government of President Xi Jinping has helped precipitate this crisis. The current administration, which is known more for ideological fervour and statist instincts than for competence, tried in 2020 to corral larger developers and reduce their political and economic power by reducing access to credit. This caused trouble for Evergrande, and, now, for Country Garden. But the reduction of credit to big developers might also help in controlling the fallout of a real estate crisis. Economists are almost united in saying that this is unlikely to parallel the financial freeze-up that followed the collapse of mortgage-backed securities in 2008. The formal banking system in China is far less exposed to risky real estate debt than it has been in the past or was in the West in 2008. Less is known about Chinese non-banking financial companies, and there is some concern that one such large institution, Zhongzhi, might miss payments to investors in an early warning of a liquidity shortage.

Even if this does not precipitate a full-fledged financial crisis, however, the timing is tricky for Beijing. Growth has largely failed to show a hefty post-Covid bump even after Mr Xi controversially reopened the country with minimal preparation last year. Many analysts have downgraded their expectations of growth in mainland China to below the 5 per cent official target. The task of rebalancing the economy away from government-boosted investment to private sector-led consumption has faltered in the wake of political crackdowns on large companies. In the past, China has escaped crises by growing out of danger or by unleashing the awesome spending power of its government. On this occasion, however, growth does not seem to be reviving and opening the government’s coffers would only exacerbate systemic problems such as a dependence on big and unprofitable investments. China’s crisis may not cause a collapse, but it is not going away any time soon.