How bad could China’s property crisis get?
H. isdaughters across China has been thrown into shock over the past week. The company building the apartments, Country Garden, lost $22.5m in coupon payments on August 6. Now the company, one of the world’s largest homebuilders, has until early September to make the payments or follow hundreds of other developers into default and restructuring. Trading in its bonds, which are worth just a penny on the dollar, was suspended on August 14.
Officials across the country are keeping a close eye. Country Garden is known for its large-scale projects in second- and third-tier cities in China. The company’s debt is less than that of Evergrande, a large company with huge debts that will fail in 2021. But at the beginning of the year Country Garden was building four times more homes than Evergrande before it left. At Country Garden’s rate of deliveries in the first half of 2022, at least 144,000 buyers will not receive their promised homes by the end of this year. A sudden debt collapse at the company would leave even more families out in the cold.
China’s housing crisis turns three this month, if measured by the introduction of the government’s “three red lines” policy, which sought to limit leverage. Throughout time, officials have struggled to manage confidence and expectations. At the beginning, many observers did not think that Evergrande could collapse, and that the government might not stop the pain. Until recently, most people believed that Country Garden was immune in origin. Since late last year officials have tried to calm the market by creating an informal list of healthy developers, including Country Garden, in which investors could be ‘ a feeling of comfort in funding and in which Chinese citizens could trust.
The calculation has changed in the last few days. Country Garden’s case is not one of Evergrande-style excess leverage. Instead, it has suffered from a loss of confidence among ordinary people – a sign that the government is losing control. After a brief rebound following the lifting of covid-19 controls, the property crisis has intensified. Prices are falling. Sales among the 100 largest developers fell 33% in July compared to a year earlier. Country Garden’s fell 60%. The company’s decline is forcing market watchers to face their deepest fears about the property sector.
One is that real estate supply chains are collapsing. Over the past three years suppliers of materials, along with the engineering and construction companies that build houses, have not been paid on time by developers. But so far the backbone of this department has withstood the pressure. That could change as developers get tighter on cash. The decline in payments to suppliers is already visible. Between 2021 and 2022, Country Garden transfers to such companies fell from 285bn yuan ($44bn) to 192bn yuan, according to s&p Global, rating agency. All are almost certain to fall further this year. Although the largest contracting companies may survive with the help of the government, it is not difficult to imagine that the large number of engineering and material companies that do the work will fall to the ground.
Another concern is that the crisis is spreading to state companies. Since 2021 Chinese developers have been almost completely excluded from international bond markets. But the onshore debt market has remained open to state-backed companies. The large Chinese investors who dominate the market so far have provided a degree of stability; they have not cast off the credibility of developers the way asset managers in Hong Kong have. Any change will cause trouble. And in recent weeks investors have weighed on the domestic bond market. Sino-Ocean, a state-owned developer, has shown signs that it may struggle to repay debt. Home buyers have chosen state developers because they are considered safer. If the crisis hits state-owned companies, that idea would be ruined.
Fears that a developer collapse will bring down a major Chinese bank have largely been dispelled. Banks’ exposure to developers, analysts say, is reasonable. They would survive even when a company like Country Garden collapsed. But other types of diseases cannot be ignored. If property continues to weaken, the government may ask banks to offer more loans to the industry, says Michael Chang from cgs–what Securities, broker. This would bring back devaluation and also bad credit allocation at a time when the Chinese economy is suffering.
No greater concern comes to the minds of officials, however, than threats to social stability. Country Garden may need to cut prices to generate sales. This could create competition and more rapid price falls across the industry, pushing people to delay home purchases in the hope that prices will fall further. During past recessions, those who bought homes too soon, missing out on a discount, have protested and demanded a corresponding reduction in price.
Of course, Country Garden’s biggest creditors aren’t banks or bondholders, but people who have paid for homes in advance. About 668bn yuan, or about half of the company’s liabilities, were put up by domestic buyers. Last year thousands stopped paying their mortgages in protest at years of delays in delivering homes. There is now a risk of much wider protests throughout the 300 cities in which Country Garden is building.
So far officials in Beijing have decided against direct intervention in the real estate market. Country Garden certainly has the $22.5m it would need to cover payments this month. By not paying up, their bosses are signaling a desire to restructure their debt – perhaps promising that the company is too big to fail. This puts the central government in an interesting position. Allowing a Country Garden to fail could lead to wider panic, more economic pain and more potential shortages, risking contagion and social unrest. But stepping in with a rescue package would put officials on the hook for much more bailouts, and set up an unsustainable industry. ■
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