The crisis that China has to have?

It was late 2021 when property giant Evergrande was declared to be in default. At the time, headlines were ablaze comparing Evergrande to Lehman Brothers.

Of course, given that we are talking about China, it was never likely that we would see anything similar to the chaos in global financial markets that ensued after Lehman’s bankruptcy announcement. There was no catastrophic loss of confidence in financial markets and there was no seizing up of credit markets.

Indeed, Evergrande seemed to fade from media headlines altogether.

That is until now. Last week, Evergrande filed for bankruptcy in the US, which continues to undergo restructuring of debt obligations. It follows Country Garden, which was once China’s largest developer, which missed coupon payments on its US dollar-denominated debt earlier this month.

What is going on?

Is the financial crisis in China that many pundits have been predicting for many years about to happen?

While there haven’t been too many major events that you would associate with a traditional financial crisis, there has been little good news for China’s property market over the last two years.

You could say that China’s property market has been in crisis the whole time.

That said, you wouldn’t know it by looking at some key housing indicators. For example, new house prices were down only 0.1% in the year to July. That’s an annual fall. Just 0.1%. From an estimated peak in September 2021, prices were down just 0.9%. Hardly the sort of price falls you would expect with a property market in trouble. 

But the lack of a price correction is probably because authorities haven’t been letting prices fall. Local governments and regulators are reported to have warned developers against offering deep discounts for properties, for fear of causing “social instability”. But by not allowing prices to correct, it has led to major falls in residential home sales. In 2022, floor space sold was down 26.8% from 2021.

 

No wonder property developers are having ongoing problems with cash flow and meeting debt obligations, even those which were not perceived to have taken up excessive leverage. The hit to revenue for developers is amplified if they are not able bring prices down to sell their properties. There is also the large number of unfinished apartments as cash-strapped developers struggle to pay suppliers to complete these projects.

 

Despite these troubles, it seems unlikely that a Lehman-style collapse is on the cards. Above all, authorities have the means and the ability to prevent a loss of confidence across the whole financial system.

If deemed to be a systemic risk, Country Garden’s assets could be bought up by State-owned entities, or banks could be forced to provide further lending to the developer.

However, the extent at which authorities are willing and able to do to provide support to the sector is another story. Official rhetoric may have removed the phrase “houses are for living in, not for speculation”, but that doesn’t mean that there is an aim for the property sector to be as significant a part of the economy as it once was. The property sector is not part of the long-term strategic vision, which includes sectors such as advanced manufacturing, AI and green technology.

It says a lot that big player developers, like Evergrande and Country Garden, are in their predicament in the first place, and there is a reasonable chance that Country Garden will be allowed to default.

But for property to no longer play a major part in the economy, there likely needs to be a price correction for housing of some sort. Otherwise, the pain in the property sector will only be more prolonged.

The property sector and rising property prices also played a big part in supporting the rest of the economy, such as boosting wealth for consumers and revenues for local governments which in turn supported spending on infrastructure – another key driver of economic growth over the past 20 years.

There might not be a sudden collapse of systemic-wide confidence like in a typical financial crisis, but the negative impact of what is happening in the property market is still being played out - perhaps for years to come.