Economically, news from China has been extremely positive over the last decades, but now some clouds seem to be looming over China’s economy. First the Covid-crisis depressed growth, and since 2022 there is talk of a ‘property crisis’, while property and related industries are estimated to –directly and indirectly– contribute as much as a quarter of China’s GDP –with construction amounting to 7 percent and real estate to another 6.8 percent. So, what’s the problem?
In 2021 and the first half of 2022, several large Chinese property developers defaulted on their bonds. Because of liquidity problems they halted payments on their loans or bonds obligations. Some abandoned half-built projects, leaving buyers that had put up down payments on properties in trouble. In response, some of these buyers halted their payments on mortgages for their unfinished apartments. Such mortgage strikes are worrying, not only for Chinese banks, but also for authorities.
In general, the confidence of Chinese homebuyers declined sharply recently: sales went down 35% in the first five months of 2022 and housing prices also declined. All of this only brings property developers further into trouble. On top of that, the slowdown in property results in less land for future development being sold, while land sales make up some 1/3 of local government revenues. Between June 2021 and June 2022 land sales were down by 65 percent.
Psychology always plays an important role in economics, and also in crises like these. When people lose trust in the property sector, or worse, in the banking system, this can become catastrophic. In Henan province, where most of the problems around property occurred and people decided to go on ‘mortgage strike’, there was also another feat of distrust in the banking system recently. Because of fraud at a local bank, depositors’ funds were frozen. Subsequently, mass protests broke out.
The snowball of the property crisis seems to be steadily growing and rolling downhill. Could it drag down China’s financial sector? Although China is very different from the US, the present development makes one think of the global financial crisis which started as a small issue in the American collateralized sub-prime mortgage market. As for now, Chinese authorities are doing everything to contain the problem and to ensure that the property crisis does not spread furtheror triggers a banking crisis. No doubt they will find a way to resolve it for example because the government committed itself to ensure the property buyers the delivery of stalled projects.
Global bank UBS sees three potential scenarios from here:
- Our base case (60%) is that a coordinated policy response will ensure the real estate crisis is contained and does not derail China’s general post-COVID recovery. Major banks’ coverage of non-performing loans (NPL) is adequate to withstand the sharp rise resulting from the increase in mortgage deferrals. Assuming a loan-to-value ratio of 40%, potential mortgages with payment suspension risk are estimated at CNY 900bn, or 1.7% of outstanding mortgages (based on E-House data). But the property market will remain troubled for some time, and investors should steer clear of related assets.
- In the bull case (10%), central and local governments work together to offer a very strong response. We would enter this scenario if a real estate relief fund is set up at the central government level (at a scale target of CNY 200–300tr as reported by international media). In this case, strong central and local government support effectively ends the mortgage boycott, restarts construction for certain pre-sold units in the next six months, and results in a recovery in property market sentiment. But this is very unlikely given the central government’s intention to curtail its intervention in local markets.
- In the bear case (30%), policy coordination is not enough, leading to a series of additional defaults and a sharp rise in bad loans for banks. This could cause economic growth to dip below 3% for the year. In this scenario, most of the suspended projects may not be able to resume construction and market sentiment would likely spiral downward as mortgage boycotts start to rise again. As a result, banks would need to start provisioning more in view of increasing NPLs stemming from mortgage defaults and from the entire real estate supply chain. The loss of confidence in China’s housing sector could spread and drag down the overall wealth of Chinese households and the broader economy.