After decades of depending on a model where borrowing was used to finance construction, Beijing faces tough decisions regarding its housing market and economic prospects.
When China’s housing market appeared to be a surefire investment, Gary Meng’s parents purchased an apartment from China Evergrande, the country’s largest real estate developer. Subsequently, the company proposed managing their wealth, which the family saw as a low-risk opportunity. Evergrande had a global reputation and held significant political importance within China’s booming economy. They invested all of their savings in this venture.
However, in 2021, Evergrande experienced a default, marking the onset of a real estate crisis that has had profound effects on China’s economy. It led to the downfall of some major companies and left numerous home buyers waiting for over a million undelivered apartments. Just recently, another beleaguered real estate firm, Country Garden, announced a cash shortage, indicating that the worst may still lie ahead. Together, these companies are burdened with a combined debt of $500 billion and face significant challenges in the near future.
The ability of Beijing to mitigate this crisis is now in question, as consumers continue to display disinterest in real estate purchases, even during a recent Golden Week holiday, which is typically a peak period for property sales.
The housing crisis poses a formidable dilemma for China’s political leadership. They aim to reduce the country’s long-standing reliance on real estate to fuel economic growth, but this endeavor is exacerbating a crisis of confidence. Financial markets are doubting the sustainability of China’s economic success, and households are losing faith in the Chinese Communist Party’s promise of a brighter economic future.
Mr. Meng, who invested $300,000 in Evergrande’s wealth management arm and is still owed $194,000, said, “In the past, I believed in the government and the party and the country.” However, after being cautioned by the police not to file a complaint with higher government authorities, he expressed his disappointment, stating, “Now I can only say that I am quite bitterly disappointed.”
Economists, investors, and central banks worldwide are sounding alarms about the risks to China’s financial stability and urging Beijing to take action to stabilize the housing crisis. The Chief Economist of the International Monetary Fund, Pierre-Olivier Gourinchas, emphasized that China’s real estate crisis is eroding confidence and causing financial challenges. He made this statement at a summit of policymakers in Marrakesh, Morocco. Both the World Bank and the IMF have revised down their growth forecasts for China’s economy.
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Economists suggest that China needs to rebalance its economy, shifting away from heavy reliance on investments in infrastructure and real estate and toward a greater emphasis on consumer spending.
Julian Evans-Pritchard, China country head at Capital Economics, explains the challenge of supporting this economic transition without causing another property bubble or exacerbating existing issues. He emphasizes the importance of stabilizing the property sector for a successful turnaround.
Chinese authorities have attempted to boost real estate sales recently, but with limited success. Companies like Country Garden are struggling with large unpaid debts and unfinished housing projects.
The central role of the real estate market in China’s economy took years to develop. For a long time, housing was a sure bet, providing revenue for local governments and investment opportunities for families. This led to a surge in jobs in construction, painting, landscaping, and real estate.
Before its downfall, Evergrande was a symbol of success that ran parallel to China’s growth. Founded in 1996 by Xu Jiayin (Hui Ka Yan), it played a significant role in urbanizing large parts of the country as China transitioned from an agrarian economy to a capitalist one.
As Evergrande expanded rapidly, borrowing from Chinese and foreign investors, it became a massive conglomerate with numerous subsidiaries. It ventured into various sectors, including bottled water, pig farming, electric cars, and professional soccer.
Evergrande’s business model was adopted by other developers, making real estate the largest contributor to China’s rapid growth. In 2020, the government introduced the “three red lines” policy to curb the mounting debt of real estate companies. This policy imposed limits on developers’ borrowing, leading companies like Evergrande to seek riskier financing methods to avoid a cash crisis.
Evergrande, for example, increased pre-sales of apartments before construction and urged employees to invest in short-term loans or face bonus losses. It also persuaded existing apartment buyers to invest in high-return financial products. Many, like Mr. Meng and his parents, were promised substantial interest rates. However, interest payments stopped in the following year.
The extensive borrowing in China led to excesses in other sectors. Insurers invested in hotels, and an entertainment company acquired a Hollywood studio. This economic activity allowed the government to overlook the growing bubble, as these companies, including Evergrande, contributed to local economic growth.
Now, with many of these companies facing financial difficulties, there are uncertainties about Beijing’s next steps. Experts agree that China will not return to the era of excessive real estate expansion. However, questions persist, particularly amid a gloomy economic outlook.
Addressing the decades-long rise in real estate prices without causing widespread economic pain is a formidable challenge. All stakeholders, including banks, local governments, and households, have much at stake. The political issue at hand is deciding who will bear the losses.
Until now, the government had made it clear that homebuyers would not be the victims of the real estate market reckoning. Despite Evergrande’s default, officials permitted the company to continue construction on 300,000 apartments last year.
Evergrande’s relevance for policymakers seems to have waned, especially after the detention of its founder, Mr. Xu, on suspicion of “illegal crimes.” Several top executives and employees of its wealth management division have also been questioned.
To ensure that the apartments promised by now-bankrupt developers are completed, estimates suggest it will cost between $55 billion and $82 billion. Additionally, many suppliers, including painters, builders, and brokers, are owed over $390 billion. Foreign creditors who lent substantial amounts to Chinese developers are working on complex restructuring plans to recover their investments.
To revitalize the economy, China’s leaders must allocate more funds to support private businesses and households, encouraging spending. This includes enhancing rural pensions and expanding healthcare coverage.
In a broader sense, reforms are needed to manage the demand side of the economy without relying on real estate as a lever. Policy actions and visible events are now crucial to instill confidence in the economy’s future.
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