The risk to the Chinese economy is much greater than expected

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Of: Christiane Kuehl


Construction boom in China: semi-finished residential complex on the outskirts of a town in the hinterland of Jiangxi Province © VCG / Imago Images

China’s real estate sector has overheated and residential construction has been booming on credit for decades. But now the apartments are empty everywhere. Now the great tremor begins.

Munich – Investors and homebuyers of ailing real estate group Evergrande are still waiting for their money or homes. According to the motto: Hope dies last. But the crisis that is slowly opening up for all to see also opens up a deeper problem: China’s hot real estate market * is gradually cooling down after years of oversupply.

On the one hand, this is due to politics, which for years have posed high obstacles to speculative buying and excessive indebtedness. But that’s not all: in some places there is a concentrated oversupply of apartments that no one is buying. It is a problem that occurs mainly outside of metropolises such as Beijing, Shanghai and Shenzhen. The country is vast and there are hundreds of cities that still have six or seven-figure populations that want to keep growing and have overloaded in the process – and development companies with them.

China: huge investment ruins

In the last ten years the reports of so-called ghost towns have been repeated: designed on the drawing board without determining real needs. Some of these well-planned satellite cities were never completed. There, the bullets are lined up along the deserted streets, only a few neighborhoods are inhabited. Others have come to life over the years, such as the Zhongdong New District in Zhengzhou in central China or the Binhai New Area in the port city of Tianjin.

But even before the Evergrande collapse, tens of millions of homes across the country were considered empty. In recent years, the problem has only gotten worse. The US television broadcaster CNN cites Mark Williams, Asian chief economist at Capital Economics, who estimates China has condominiums with about 30 million unsold apartments that could house 80 million people. This would correspond to almost the entire population of Germany. One thing is clear: if real estate companies don’t sell their apartments, they will be left with the debt they had to take on to build the apartments.

Additionally, Williams estimates that there are approximately 100 million homes for 260 million people that have been bought but not occupied. They are objects of speculation, bought in a bet on ever-increasing prices. Also in Beijing there are refined and well-finished residential complexes, in which only a few apartments have the lights on in the evening. It is a gigantic waste of living space artificially made more expensive in this way.

China: Urbanization has prompted rapid housing construction

For decades, urbanization and construction have been important catalysts for China’s unprecedented growth. In 1978, only 18 percent of the population lived in cities; last year it was 64 percent. The country now has more than ten megacities with over 10 million inhabitants. More than a tenth of the world’s population lives in hundreds of Chinese cities. Without rapid housing construction, this high rate of urbanization would not have been possible. Initially, all the actors seemed to take advantage of it.

Municipalities made money by selling land to real estate developers. For some, this has been the main source of income in their families, because the lower levels of government have virtually no tax revenue of their own. No wonder, then, that local authorities have rushed headlong into the business of urban development. The market with its rapidly rising prices was equally attractive to real estate developers. According to various estimates, the sector accounts for between 25 and 30 percent of China’s economic output, much more than in other countries.

China: fight against over-indebtedness

But growth had a problem: municipalities and real estate companies got into debt to finance the construction boom. Municipalities are still fueling this debt-financed housing growth: according to a news agency report, the publicly promoted construction boom has turned into an economic recovery following the crown pandemic in 2020 and 2021 Bloomberg funded by a record 3.75 trillion yuan ($ 580 billion) loan from local governments.

Given the real estate bubble, credit growth and speculation, Beijing had already decided to intervene directly with companies. Beijing has targeted real estate companies even before the technology sector, which the government has also been targeting for several months *. As early as August 2020, the authorities requested a report from the official news agency Xinhua 12 real estate giants to urge them to pay off their debt. Shortly after, Beijing adopted the so-called “three red lines”:

  • The net debt of real estate companies cannot exceed 100 percent of the equity capital.
  • Total liabilities cannot exceed 70 percent of the value of all assets in a company.
  • Each company must have liquidity at least equal to its short-term debt.

The bubble did not burst. However, Beijing’s political intervention has significantly cooled the market. It showed that the Communist Party * and the state have the last word. Prices are currently only slowly rising, sales are stagnant or declining, after a brief hype at the end of the pandemic. “Residential demand in China is entering an era of sustained decline,” predicts Mark Williams.

Evergrande could not meet the new requirements

Evergrande did not meet the “red lines” in 2020. It could therefore no longer issue bonds to pay off debts, which it had always done until then. The group has amassed a mountain of debt of around € 260 billion * through its pump-funded expansion in recent years. Since September 2021, Evergrande has repeatedly missed deadlines for interest payments or debt repayments. Two other real estate developers, Fantasia and Modern Land, have recently been unable to honor their debts. It is still unclear whether other companies have had problems.

Central bank spokesman Zou Lan * said the contagion risk to the Chinese economy was “manageable” on Friday. Evergrande has been “very poorly managed” and “blindly” expanded. According to Zou, authorities are now urging Evergrande to “sell parts of the business and accelerate the delivery of construction sites.” Beijing. According to one of the CNN Bank of America analysis cited above, Evergrande has sold 200,000 housing units that have not yet been delivered to buyers; the sale of unfinished apartments is absolutely common in China *.

Despite everything, central bank spokesman Zou Lan believes the real estate sector is generally healthy. A few months will show if he is right. According to many experts, these are crucial to how much the Evergrande crisis will damage the Chinese economy. (ck) * is an offer of IPPEN.MEDIA.

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