The story of China’s rapidly declining economy has been in discussion for a long time. The events of the world’s second largest economy plunging into deflation, with many companies defaulting on debt payments and the fertility rate at historic lows, are being reported in global sections of the media around the world.
Perhaps the biggest crisis China is facing in this is its real estate sector.
On Thursday, Evergrande, one of the nation’s largest realty groups, filed for bankruptcy protection under Chapter 15 in New York. With the filing, the group is aiming to restructure $32 billion of its debt, according to Bloomberg. Along with this, it has also been said in the report that another real estate giant Country Garden may also be heading towards default.
But what’s wrong with the Chinese real estate sector? Here’s an in-depth look at the crisis
Migration, property boom and free credit
China’s real estate boom began in the 1990s when people began to migrate from rural areas to major cities. In the late 1990s, a third of people in China lived in cities. According to the latest official figures, more people now live in cities than in rural areas.
When emigration began in the early 1990s, the Chinese government provided migrants with a government apartment, which they were later allowed to purchase at a steep discount. This demand for homes provided a golden opportunity for real estate companies.
They had ready demand from the government and were also given cheap loans to construct these apartments. Most people believe that this boom was the world’s biggest boom in the real estate sector, which allowed companies like Evergrande Group to earn huge revenues.
Its effect is also visible in the accounts of the company. From $0.2 billion in 2004, the company’s revenue grew to $79.8 billion in 2020, an annual growth rate of 44 percent.
sacred real estate
With the rapid expansion of the real estate sector, the Chinese economy witnessed a period of rapid economic growth. Between 1990 and 2015, the Chinese economy grew at an annual rate of between 7.5 and 14.2 percent.
Due to high debt and easy funding from domestic and international lenders, the real estate sector remained the main driver of the country’s growth. In 2017, it accounted for 28.7 percent of the total gross domestic product (GDP). This was much higher than the 20 percent in Britain and 17.3 percent in the United States.
In addition, it also played an important role for companies in other sectors, who used their properties as collateral to get more loans.
Slow economic growth, Covid-19 and falling demand
After the recession of 2008, lenders around the world started scrutinizing the real estate sector harder. They became more cautious in lending money to developers. The cash flow, which was needed to keep the projects going, slowly started drying up.
This slowed down the pace of development of housing projects in China and in turn home buyers started putting less of their money in the sector for fear of losing their savings.
Due to skewed demographics, China’s economic growth also began to slow down after 2010. From 10.6 percent in 2010, the annual GDP growth rate in China fell to 6 percent in 2019.
The COVID-19 pandemic further hit the Chinese economy, which saw one of the strictest lockdowns anywhere in the world. In 2020, the country registered a GDP growth of only 2.2 per cent. This was not particularly bad compared to the US or European countries, but much slower than China’s previous growth rate.
The slow growth rate also brought another problem: low demand for housing.
Slow economic growth has reduced the disposable income of households. He started investing less money in real estate. This affected the developers as they had already taken the money and used it to develop the projects.
The final hammer came in the form of a policy that the Chinese government introduced in August 2020.
three red lines policy
In 2020, when the Chinese economy faced difficulties due to the pandemic, its government realized that it could not lend money to real estate companies with the same easy terms.
The “three red lines” policy was introduced with three fixed ratios property developers would have to adhere to in order to gain access to more credit.
One, the liability to asset ratio had to be less than 70 per cent. Second, the net gearing ratio or debt-to-equity ratio had to be less than 100 per cent. The third was the cash-to-short-term debt ratio, which had to be greater than 1. These ratios indicate that the company had sufficient cash to support its business.
Interestingly, more than half of China’s top developers failed to meet the requirements. Now, they were not allowed to borrow money even from domestic banks. Hence, customers were unable to lend money to these developers and banks were not allowed to provide loans to them. Trouble has begun for the country’s property sector.
In 2021, Evergrande Group became the first major developer to show stress in its balance sheet. They started defaulting on repayment obligations.
This prompted foreign banks, which still have large investments in the Chinese real estate sector, to tighten lending through bonds and other instruments. The third and last source of income of these companies has also stopped now.
In many ways, the Country Garden crisis is a product of this austerity.
Demographic concerns, slow growth and the problem of abundance
Now, the urban population growth rate in China has fallen. According to official data, it has fallen from 4.1 percent in 1996 to 2.1 percent in 2020. It is also grappling with the increase in the number of old people who cannot contribute much to the development of the country.
Furthermore, the Chinese economy has failed to recover from the strict lockdown imposed by the Xi Jinping administration.
Despite the announcement of financial support policy in November 2022 and again in July this year, the sector has failed to recover.
Economic growth slowed to 0.8 per cent in the three months ending June, from 2.2 per cent in January-March, according to Chinese government data. This equates to an annual rate of 3.2 percent, China’s weakest rate in decades.
In addition, the unemployment rate among urban workers aged 16 to 24 reached a record 21.3 percent. The Chinese Bureau of Statistics has now said it will pause updates while it “refines” its measurements.
This has become a big problem for the developers. They do not get access to money and thus are unable to complete their ongoing projects. With most of his projects turning into “ghost” construction, he is unable to service his loan obligations, and is slowly spiraling towards bankruptcy.
Will the Chinese government revive its vital real estate sector in the days to come? The answer, yes or no, will likely come in the coming weeks.