By Amit Ranjan Alok
The real estate sector in China is currently grappling with a severe existential crisis. This crisis is characterised by a series of defaults on offshore dollar-denominated debts by Chinese property developers, coupled with stringent government-imposed limits on debt levels and arrest of Hui kaYan, boss of one of the largest real estate companies, Evergrande. Consequently, these developers are urgently seeking bailouts to navigate the dire financial situation they find themselves in. Concurrently, homebuyers have initiated protests due to delayed mortgage payments, leading to a complex web of interrelated issues with explicit political implications.
The escalating protests among homebuyers represent a growing embarrassment for the leadership of the Chinese Communist Party (CCP). This trend signifies that significant challenges lie ahead for the influential members of the CCP. The discontent among homebuyers in China towards major property developers serves as a manifestation of the country’s substantial difficulties in effectively managing crony capitalism. This economic environment has allowed debts, payment defaults, and the non-delivery of homes to erode trust in the Chinese economy. Notably, the real estate and infrastructure sectors, which together account for one-third of China’s GDP in terms of investment, are currently experiencing considerable distress.
“Beneath the dazzling facades and urban sprawl of Chinese cities lie hidden systemic risks born of extravagance.”
The evolution of cities and reforms implemented since the late 1980s have enticed young urban residents and migrants to invest their wealth in real estate. Presently, approximately 80 percent of household wealth in China is tied to land and real estate holdings. Societal expectations and the significance of homeownership as a prerequisite for starting a family and accumulating wealth have placed substantial pressure on young Chinese citizens. This has driven many young Chinese individuals to view property ownership as a generational investment. Given that the average age of a homebuyer in China is approximately 29.5 years, the anxiety surrounding homeownership is especially pronounced among the younger demographic which led to huge demand for homes in the Chinese economy.
Chinese urban centres have encountered substantial multifaceted challenges, emanating from the dynamics of globalisation, migration, and market-oriented reforms. Nevertheless, the remarkable expansion of China’s urban areas has concurrently engendered a thriving real estate market. This expansion has manifested in the proliferation of real estate developers and their associated projects, a trend notably accentuated since the year 2000. During this period, there has been a substantial proliferation in the availability of commercial housing and property developments. The escalating land values have presented lucrative opportunities for financially strained local governments. The insatiable pursuit of financial gains has led to a deliberate regulatory inadequacy and the inflation of the property market to unsustainable levels.
Hence, the expansion of urban areas and cities throughout China was underpinned by substantial systemic vulnerabilities linked to excessive borrowing. The political elites within the ruling party celebrated the remarkable growth of Chinese cities, positioning them as an alternative model of development in contrast to neoliberal globalisation, effectively sidestepping conventional city indexes or growth paradigms. Consequently, China’s internal economic transformation exacerbated inherent contradictions, resulting in significant social and political consequences. Key among these were the termination of the welfare housing system, the emergence of a fervent competition for property ownership, and the accessibility of owner-occupied housing within Chinese urban centres.
The imbalances within the property market gave rise to profound tensions among the general Chinese populace, as well as within the political and economic leadership circles. Prominent property developers capitalised on the Party’s concerns about issues such as slums, widespread squatting, dilapidated structures, and low-rise developments in suburban areas of urban China. They assured higher and more rapid returns on state-owned land, aligning with the objectives of urbanisation campaigns championed by the leadership. Moreover, the state permitted private developers to invest in residential real estate, and these property developers rose to meet the expectations of state institutions, which included projects related to healthcare, education, provincial redevelopment initiatives, and urbanisation efforts.
Through the process of transforming housing into a commodity within the real estate sector, the Chinese government aimed to alleviate the financial and welfare burdens on the state while simultaneously providing substantial benefits to state-owned banks and state-controlled construction enterprises. Real estate swiftly assumed a pivotal role in China’s development and economic prosperity. With leaders endorsing real estate projects and financial institutions and corporations offering crucial resources, urban properties became highly attractive to young Chinese individuals. Consequently, a significant portion of the Chinese population sought loans to acquire homes, resulting in a notable increase in homeownership rates. In 2014, approximately 70 percent of urban residents possessed residential properties, a figure that surged to 80 percent by 2020. China’s Central Bank even projected that the urban homeownership rate would eventually reach an astonishing 96 percent.
The real estate saga
However, the Chinese government miscalculated the potential of property developers to sustain a balanced macroeconomic equilibrium. During the 1990s, as private enterprises sought to spearhead China’s market-oriented reforms, property developers gained prominence due to their capacity to stimulate rapid economic growth. This growth trajectory extended to property management and development, the construction sector, and the commodity industry, collectively fostering the perception of a promising real estate sector. Regrettably, the escalation in the debt-to-common equity ratio within the construction industry over the past decade went largely unnoticed. The magnitude of borrowing appeared unsustainable, and property developers found themselves unable to reduce their dependence on debt financing, as doing so would have exposed vulnerabilities within their financial positions, potentially leading to insolvency. This predicament had adverse implications for China’s long-term economic prospects. The issues became apparent when property developers started postponing projects and utilised prepayments from homebuyers to sustain their cash flows.
In the recent past, Chinese property developers had been fortunate beneficiaries of favourable conditions, including access to relatively affordable land resources and robust demand for housing, which bolstered their financial reserves significantly. However, the ongoing financial crisis in China, triggered by widespread defaults on debt repayments by these developers, has led to the emergence of a severe systemic crisis. Notably, defaults on offshore bonds by Chinese property developers have underscored their overreliance on offshore financing, exacerbating the challenges they face. Consequently, the high-leverage financing model employed by these developers has failed to yield the expected returns, ultimately culminating in the collapse of the property market bubble.
Furthermore, the Chinese government’s decision to enact stringent restrictions on the leverage capacity of property developers, thereby curbing their borrowing capabilities, has further exacerbated the real estate crisis and damaged the reputation of these developers. While initially, large-scale construction projects appeared to enjoy state support, this was the case only until certain developers encountered severe financial distress, leading to project delays stemming from acute cash shortages. The defaults by Chinese property buyers set in motion a chain reaction, with an increasing number of property developers confronting mounting difficulties in servicing even the interest on their loans.
In the face of escalating debt burdens and a growing risk of impending insolvency, global offshore stakeholders have become increasingly apprehensive. Some have resorted to legal actions, while others have felt compelled to infuse additional capital into Chinese developers, while a few have even chosen to write off their loans entirely. Ultimately, these developments harbour the potential for catastrophic consequences for China’s domestic economy and pose a significant threat to global financial stability.
Political manoeuvre to containing systemic risk
Beijing’s strategy of restricting property developers from leveraging and curbing speculative property purchases has yielded limited success thus far. This is primarily because developers are currently grappling with severe challenges in meeting interest payment obligations. Even if developers attempt to sell their properties, they face difficulties in doing so at the prices originally set, as potential buyers exhibit reluctance to invest. Furthermore, property developers are constrained from selling all their properties, as many have already been sold or pledged as collateral against existing debts. The Chinese government’s regulatory approach to controlling asset sales, stabilising asset prices, and potentially averting a market bubble burst has further complicated the developers’ search for viable solutions.
The outlook for the real estate market remains uncertain in the foreseeable future. The situation could deteriorate if deleveraging efforts are delayed, especially in the context of declining revenues and increasingly unsustainable operating expenses relative to tighter liquidity, i.e., the debt-to-capital ratio. Inflated growth initiatives pursued by firms and local authorities to curry favour with Beijing have led to excessive leveraging, resulting in turmoil in the bond market and triggering public protests. To address these issues, the Chinese government must adopt a comprehensive approach encompassing not only the real estate sector but also enterprises across various industries. The state needs to ensure that developers adhere to established regulations and that regulatory authorities enforce them impartially. Additionally, the government can consider implementing social welfare programs to support citizens affected by the ongoing crisis.
There have been speculations about the State Council considering the inclusion of the real estate sector within the national Social Credit System. While this system is typically used to assess the trustworthiness of entities, it can also serve as a mechanism to monitor compliance, detect legal violations, and control developers to prevent excessive leveraging and associated risks. The younger generation, in particular, feels disillusioned as their hard-earned savings and social well-being are at stake. To avert growing unrest and anxiety among young Chinese citizens and to instil confidence in Beijing’s commitment to the rule of law, the government must demonstrate its willingness and ability to address real estate challenges comprehensively. Structurally, Beijing needs to reevaluate its role in funding local authorities and identify alternative revenue sources to discourage the habit of local governments resorting to excessive leveraging for revitalising local economies.
The author is research Scholar in Jawaharlal Nehru University, New Delhi. He has a deep interest in Chinese Political Economy. And, he has also completed his masters from the same University in International Relations.
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