Gunners Shot

In Jul 2022, I had written in my earlier article China’s Twin Ponzis @ https://gunnersshot.com/2022/07/31/chinas-twin-ponzis-turn-the-fire-breathing-dragon-into-a-sick-lizard-by-lt-gen-p-r-shankar-r/ that property sector is about 30% of China’s GDP and a major driver of its economy.  In China owning a house is a symbol of prosperity, security and wealth. Every Chinese aspires to own a house(s). This resulted in a housing boom with four  players – the buyer, the developer, the local bank and the local government. In China, property is transacted on a pre-sale model. The buyer places a deposit with the developer after taking a loan against his savings/estimated earnings from a bank. He begins paying a mortgage on a house that has not yet been built. The developer collects pre-sale cash from an ever-growing number of apartment buyers. He also collects cash from individual investors and banks willing to invest in his mega projects. The developer uses the cash to launch more projects. The local governments become active facilitators for the banks, developers and buyers since 30% of their revenues come from land transfers and construction related taxes. This spiral drives up costs of land, raw material, cost of housing etc.  This ever widening circle of debt-fuelled construction creates wealth to induce celebration.  Sale of luxury items zoom up.  Jobs are created in the construction, steel, cement, and other industries. This looks awesome on a China GDP graph. So what if  all apartments are not sold or ghost cites are getting created?  

Trouble surfaced last year when property giants like Evergrande, Kaisa, and Fantasia started defaulting on billions of dollars’ worth of loans/bonds. Incomplete projects left homebuyers high and dry with only mortgages to repay. Reflexively, home sales and property prices fell drastically. Developers stopped buying land from local governments. Local governments became cash starved due to fall in land sales and taxes. They faced shortfalls of up to 0.9 trillion USD. As the economy slowed, unemployment and pay cuts increased across the board.  

At that time the contagion meta-stated across 235 projects spanning 91 cities in 24 of China’s 31 provinces. Homebuyers even refused to pay mortgages on loans since homes were not being delivered. People refusing to pay their mortgages, were being threatened officially  with social credit down-gradation. They took to streets. Protests outside banks in Henan spurred a government in panic to step in and offer some sops to the people and avert the crisis.  

The drawdown of the property sector is now irrevocable. Unfinished buildings and ghost cities dot the landscape. Many of these unoccupied units are investment properties for citizens who already have primary residences. They cannot be sold at profit anymore. Demand for property in future will decrease. Developers owe billions to Chinese bondholders and foreign investors. There are huge backlogs of pay to construction workers. Many listed developers are still facing liquidity problems. Small banks are at risk of collapse.  When the going was good real-estate was the prime driver of Chinese economic growth. Now it is the prime drag. 

Michael Pettis , a senior fellow at the Carnegie Endowment has his finger on the real estate economy of China. In the article above he recently wrote : Even with prices having declined in the past two years, and the sharp fall in property-related activity, China needs a further substantial contraction in the role of real estate in its economic activity. Property prices relative to household income are still two to four times in China what they are in the rest of the world, and the sector accounts for more than twice the share of economic activity….

Because China experienced one of the largest and most sustained surges in property prices in history, it shouldn’t be surprising that households, businesses, banks and government entities became extraordinarily dependent on the property sector. The longer this process continued, the more urgent it became to rein in the sector.

But, at the same time, the longer this continued, the more painful it would inevitably be to reverse it. When much of the economy is explicitly or implicitly betting on an expansion in the property sector, it cannot come as a surprise than any reversal of this expansion will create significant financial distress.

So what can policymakers do? They cannot allow the property sector to expand, or even stabilise at current overextended levels, without creating even larger long-term costs for the economy. But they also cannot rein in the sector without suffering much greater short-term costs than they may be able to bear politically.

For now, Beijing seems to want to stabilise the property sector and slow the pace of adjustment to reduce financial distress. It is not clear, however, that this a realistic goal. In a speculative market, it is the expectations of rising prices that generate the demand for more rising prices, and once these expectations are reversed, it is very hard to prevent prices from falling.

With real demand expected to fall sharply in the next few years, it will be impossible to wring speculation out of the property market without much lower prices and a significant increase in the spread of financial distress.

Besides heavy weights like Evergrande and Kaisa many other developers, including Fantasia Holdings Group, Modern Land (China) and Sinic Holdings Group, have defaulted on their debt in recent weeks. The excerpts of articles from SCMP which I have put out tell their own story.

As I was about to post this article two issues came to my notice. Firstly China’s population is in permanent decline and Secondly its GDP has slumped. Once you finish reading this article , please also have a look at my previous post on decoupling @ https://gunnersshot.com/2023/01/07/a-peek-into-every-day-china-decoupling-blues/ , you will realise that China’s decline has really started.