The real estate sector accounts for 29% of China’s GDP.
In the reform era, China witnessed unprecedented economic growth and saw the emergence of a “middle class” (中产阶级), estimated to be over 400 million, according to the 2019 White Paper on China’s “New Middle Class” (新中产阶级). The “New Middle Class”, projected to be 200 million strong, has a decent annual income of more than 100,000 yuan, and mostly lives in the tier one and tier two cities of China. The middle class has been instrumental in driving consumption in China, and interestingly holds around 70% of collective wealth in real estate. For the “New Middle Class”, the ratio is given at 56% by the White Paper. In recent years, owing to the bad debts of the real estate developers, stringent Covid-19 lockdowns, domestic and global economic slump, the risk of relying on real estate investment is getting dangerous. The sector has increasingly come under the scanner of the party-state for irregularities, corruption, delivery defaults and a serious debt crisis.
It all started with the Evergrande (恒大) fiasco in late 2021, but snowballed in June 2022, when the same company issued a notice that Evergrande Longting Project in Jingdezhen City, Jiangxi Province had been completely suspended owing to unavailability of funds. The crisis engulfed the banks too; many froze the deposits of their clients, as was witnessed in Henan and Nanjing, resulting in protests and sloganeering in front of the banks. Worse, the customers of “forward housing delivery system” (期房制) have suspended mortgage loan payments (停贷) and some have taken to legal recourse. China’s 21st Century Business Herald 《21世纪经济报》reported that as of 14 July, more than 230 property owners across the country have collectively suspended mortgage loan payments for unfinished projects (烂尾楼) in Beijing, Shanghai, Henan, Hebei, Hubei, Hunan, Jiangxi, Guangxi, Shanxi, Liaoning, Anhui, Fujian, Jiangsu, Yunnan etc., cities and provinces, a clear indication that the trend is spreading from tier one to tier two and three cities. Shares of the 40 banks fell by 2% [in some cases by 3%], sending shockwaves across China, especially at a time when provincial governments are deep in debt amounting to over $4 trillion. Nearly half of the unfinished buildings belong to the Evergrande, which alone has a debt of over $300 billion. Other developers such as Aoyuan, Xinyuan, Xinli, Sunshine City, Shimao, Greenland etc., have also suspended their projects.
The real estate sector accounts for 29% of China’s GDP. The sector contributed to unprecedented infrastructure growth, urbanization as well as growth of the related ancillary industries like glass, cement, steel, household appliances etc., albeit there have been cases of the so-called ghost cities too. The last decade (2011-2020) saw exponential growth in the sector: the prices doubled, sales tripled and the total area sold increased by 60%. According to a report by Yicai, new home sales totalled 15.5 trillion yuan (about $2.2 trillion) in 2020, which is seven times the sales of new homes in the US in the same year. The real estate bubble gave rise to speculation, as China’s middle class borrowed heavily to buy houses. According to George Magnus, household debt rose from about $2 trillion in 2010 to more than $10 trillion in 2021, with the ratio of debt to disposable income surging to about 130%. Furthermore, in order to limit borrowing of real estate developers, the Chinese government issued “three red lines” (三条红线)—a debt-to-asset ratio of 70% or lower, a 100% cap on net debt to equity, and enough cash on hand to satisfy short-term borrowing, debts, and liabilities, adding insult to the injury. Besides, the “dynamic zero” Covid policy, global economic slump, the Ukraine-Russia conflict etc., dampened the interest of real estate companies, for they were starved of cash and were unable to finish the ongoing projects, least to talk about their enthusiasm for new projects. This has raised global concerns, as China’s real estate market is closely linked to the global market through raw material imports and development financing.
Undoubtedly, the stressed-out mortgage owners are the biggest victims, however, the systemic financial risks faced by the banks are real, for undelivered projects can only become bad debt, which in turn is likely to shake the domestic financial system of China. Will this be China’s Lehman Brothers moment? Perhaps not. The banks in China are owned by the state and so is the land. On 14 July, more than 10 banks, including the six major state-owned banks, issued statements in response to the suspension of mortgage loan payments. Industrial and Commercial Bank of China and the Agricultural Bank of China disclosed that the current suspended projects involve non-performing loans of 637 million yuan and 660 million yuan respectively, accounting for 0.01% and 0.012% of their mortgage loans. The Bank of Communications disclosed it as 99.8 million yuan, accounting for 0.0067% of its domestic housing mortgage loans. Others like the Bank of China and China Construction Bank did not disclose the specific data of their mortgage business, but both stated that the scale involved was limited and the overall risk controllable. Most of the banks stated that they have established an overall coordination mechanism and across the board investigations of the “guaranteed handover” (保交楼) of housing projects. People perhaps have not forgotten the case of Baoshang Bank in Inner Mongolia, whose ratio of non performing loans was 1.68% in 2016, but surged to 98% in 2020, the year when it was dissolved by the Chinese government.
Additionally, it has been reported that “area of suspended work” (停工面积) accounts for about 5% (about 500 million square meters) of the industry’s construction area of 9.7 billion square meters. The report posits that even if the mortgage assets due to unfinished projects reach a high level of 2%, the absolute number will still be not very large. Nonetheless, there is a counter argument that goes that even if the proportion involved is less than 1 in 10,000, the owners involved are tens of thousands. Under such circumstances, the collateral damage by suspension of mortgage loans will obviously be terrifying. However, since the banks are government owned entities, they have nothing to worry; the developers have made enough money and are lying-flat (躺平) in the times of slowdown; it is the middle class, the weakest link in the banks-developer and customer ecosystem, which has lost faith in the banking system of China, and not to forget the cities that have been dotted with the scars of unfinished projects. Whether the planned launch of a 300 billion yuan ($44 billion) real estate fund will help property developers to emerge from the debt crisis or not and restore the faith of the middle class in the property market, only time will tell.
B.R. Deepak is Professor, Center of Chinese and Southeast Asian Studies, Jawaharlal Nehru University, New Delhi.