What's happening? China's real estate sector accounts for a third of its economic output. This includes homes, rental and brokerage services, white goods producing industries and building materials.
But the Chinese economy is slowing – it grew only 0.4% in the last quarter compared to the previous year. Some economists do not expect any growth this year.
This is largely due to Beijing's zero-Covid strategy - repeated lockdowns and continued restrictions have impacted revenues and thus savings and investment.
Also, Chinese banks face $350 billion in mortgage losses in the worst-case scenario as confidence in the country's real estate market plummets and officials struggle to contain the deepening turmoil.
The spiraling crisis of discontinued projects has shaken the confidence of hundred thousands of home buyers, triggered a mortgage boycott in more than 90 cities and warned of wider systemic risks.
Thirty real estate companies have already missed their foreign debt payments. Evergrande, which defaulted on $300 billion in debt last year, is the most high-profile loss. S&P warned that if sales don't increase, more companies could follow.
Demand for homes is not increasing either, as China is undergoing a demographic shift with urbanization and slowing population growth.
Since the end of June, many home buyers have suspended mortgage payments to protest construction delays for apartments they've already paid for, putting developers' future sales and a significant source of cash flow at risk. Builders in China often sell their homes unfinished.
Fitch believes the recent rise in the number of home buyers suspending their mortgage payments due to discontinued projects underscores the potential for the real estate crisis in China to deepen, as waning confidence could stall the industry's recovery, which will eventually cause the local economy to falter.
Who is affected? Under such a stress scenario, Fitch analyzed the impact on more than 30 businesses and government agencies over the next 12 to 24 months. The firm found three of the most vulnerable to real estate problems:
1.Asset management companies
These firms have large assets backed by real estate-related collateral, which exposes them to prolonged real estate market distress.
2.Engineering, construction firms (non-government)
The industry in general has been in a difficult situation since 2021. They do not have competitive advantages in infrastructure project exposure or access to finance over their [government-related] peers.
3.Smaller steel producers
Many have been running at a loss for several months and could face liquidity problems if the Chinese economy remains sluggish, especially given the high leverage in the industry.
Fitch said construction accounts for 55% of steel demand in China.
The slowdown in real estate has already brought down broader economic indicators such as fixed asset investment and the furniture sales component of retail sales.
The businesses least exposed to real estate problems are insurers, food and beverage companies, power grid operators and national oil companies, the report said.
Banks must replenish. 'The banks are stuck in the middle,' said Zhiwu Chen, a finance professor at Hong Kong University's Business School. “If they don't help developers finish projects, they lose a lot more. If they do, this of course makes the government happy, but they add more to their exposure to overdue real estate projects.”
Credit boom. Chinese bank loans to the real estate sector have ballooned over the years… Source: PBOC, Bloomberg
Chinese banks' exposure to the real estate sector surpasses any other sector. There are 39 trillion yuan of outstanding mortgages at the end of March, and another 13 trillion yuan in loans to developers, according to data from the People's Bank of China.
Teneo Holdings chief executive Gabriel Wildau said in a note this month that the real estate market is the 'ultimate foundation' of financial stability in China.
High-risk banks may be subject to further scrutiny as authorities move to contain risks. At the end of 2021, Postal Savings Bank of China Co. and China Construction Bank Corp. accounted for approximately 34% of total loans, exceeding the 32.5% legal cap for the largest banks.
Crossing the line. Mortgage risk regulator of two big banks crossed “red line” Source: Banks annual reports 2021
S&P Global predicts home sales could drop as much as 33% this year amid the mortgage boycott, further tightening liquidity for distressed contractors and leading to more defaults. According to Teneo, 28 of the top 100 developers for sales have either defaulted on bonds or negotiated debt extensions with creditors over the past year.
Real estate investments, which increase the demand for goods and services that make up about 20% of the country's gross domestic product, fell 9.4% in June, as you can see in the chart below.
The collapse continues.The domestic market collapse deepens this year, dragging the economy and banks. Source China National Bureau of Statistics, Bloomberg
Bank earnings are at stake. After recording the fastest profit growth in nearly a decade last year, the country's lenders face a tough 2022 as the government pressures them to support the economy at the expense of earnings.
A July 19 report by Citigroup analysts led by Judy Zhang estimated that a 10 percentage point slowdown in real estate investment growth would translate into a 28 basis point increase in total bad loans, which would translate into a 17% drop in 2022 earnings.
Additionally, as China's total debt to GDP ratio is expected to hit a new record this year, consumers are reluctant to use more leverage. This sparked a debate over the risk of China falling into a 'balance sheet recession' as households and companies cut spending and investment.
Rising debt. China's debt-to-GDP ratio expected to hit a new record this year… Note: Overall debt ratio measures all non-financial sectors. Source: National Institution of Finance & Development
What's next? Capital Economics estimates companies need $444 billion to complete discontinued projects.
It's also unclear whether banks - especially smaller rural ones - will be able to cover the cost of the mortgage strike.
Even if construction restarts, many developers may not survive because home sales are unlikely to bolster the sentiment. According to China Real Estate Information Corp (CRIC), sales of China's top 100 developers fell 39.7% in July compared to the same period last year.
This crisis is the clearest indication that the Chinese economy is at a crossroads.
'The government is doing its best to find new sources of growth, but that will be difficult because the economy has become so dependent on real estate, infrastructure investment and exports over the past three decades,' Evans-Pritchard said. said.
'The period of very rapid growth in China is probably now over and this is most evident in the real estate industry right now.'
In a recent note, Oxford Economics said that while any government intervention in real estate and infrastructure could provide a short-term boost, 'it is not ideal for China's long-term growth as the government and financial sector have to help maintain an agreement.'
Conclusion? China's home prices are falling as Beijing reins in the industry, raising fears for economic growth domestically and globally. S&P Global Ratings said an increasing number of Chinese home buyers are suspending their mortgage payments, saying that China's property sales will fall by about 30% this year - almost twice as bad as previous forecasts. What China is going through right now is a policy driven crisis. China's property problems pose a significant risk to its economy, which is already under pressure from Beijing's harsh 'zero-COVID' policies and slowing global growth. While some analysts believe that the market has reached the bottom, the problems in the sector are expected to continue for a while.
However, the size of the Chinese economy, which accounts for almost one-fifth of global GDP, means that a major slowdown could still have a serious impact on global growth. The World Economic Forum estimates that every 1 percentage point decrease in China's GDP results in a 0.3 percent decline in global GDP. In a 2019 study by the Fed, economists predicted that an 8.5 percent drop in China's GDP would result in a 3.25% drop in advanced economies and nearly 6 percent in emerging economies.
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