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Explained: How China's real estate mess can put global economy on crutches

Explained: How China's real estate mess can put global economy on crutches

Explained: How China's real estate mess can put global economy on crutches
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By Yashi Gupta  Nov 11, 2021 6:57:47 PM IST (Published)

Days ago, the global investors were fretting about the possible shutdown of the world's most indebted real estate developer, Evergrande Group. While those worries seemed to die down after the developer made payments on bonds, the woes have spread to other areas. One, home sales are decreasing. Two, Kaisa Group and other developers have said they are facing unprecedented pressure and may default on payments. Three, money is hard to find these days as investors are leaving the sector.  

Even as Evergrande makes progress in resolving debt issues and staving off an official default, it seems like the problems of China's real estate market are just beginning—from rising debt levels of real estate developers to declining home sales. Since Evergrande's default, at least four developers have defaulted on payments.

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Several analysts have said they expect China's problems to remain in China, for the Xi Jinping government will contain the issue before it damages the banking system. They are also saying the issue won't lead to a broader global financial contagion.
However, a recent report states otherwise. A report by UBS has estimated if the property market breakdown gets worse, it could wipe $1 trillion off the global market.
While the International Monetary Fund predicts the global growth to advance by 4.9 percent next year, UBS has estimated a battered Chinese property market will wipe 0.5 percentage points off the growth rate, according to a report in The Telegraph. The global economy is worth $95 trillion. The figure could double if the crisis worsens, it said. This effect could flow into other world economies.
If China were to have a serious economic issue, "the rest of the global economy would have contagion from it," Jimmy Chang, the chief investment officer at Rockefeller Global Family told CNBC.
Indebted real estate developers
China's real estate developers face a $5 trillion bill. The debt, taken when the times were good, has doubled in the past four years. The proportion is so high that it is comparable with the economic output of Japan. Japan is the world's third-largest economy.
The more China tries to tackle the burgeoning debt, the more it stands to cripple the property market and developers, a report in the Wall Street Journal said.
Earlier in October, Fantasia Holdings Group failed to make bond payments. Kaisa Group had defaulted on the bond payments six years ago. One of its subsidiaries missed a payment deadline on a wealth management product, due to what the company called "unprecedented pressure" on finances due to challenging market conditions.
China's 100 largest developers saw their sales declining by over 35 percent in September, as compared to a year ago, data from CRIC showed. The largest 10 developers, including Evergrande Group, saw their sales falling by nearly 45 percent y-o-y.
Yet economists are of the view that most developers are healthy. Plus, China will act hard and fast to prevent a Lehman moment, they say.
Declining home sales
China's new home prices fell for the first time in September. The prices have declined 0.08 percent in September as compared to a month ago. Though small, it is the first decline since March 2015.
Homebuyers in China are halting purchases and getting out of the debt-ridden housing market after the Evergrande Group fallout and government curbs shook the sector. In fact, according to an NYT report, the housing market in China is now seen as "a national threat" as prices rise sky-high, just like the buildings.
Beijing has been trying to tame this market that has seen prices rising for years. When coronavirus hit the country late in 2019, even then its housing market kept booming.
The market has enjoyed a relentless journey to the moon over the few years, with prices rising higher and investors chasing deals regardless.
In March, 288 apartments in new Shenzen (something about it) sold online in eight minutes. Similarly, buyers in Suzhou (again) purchased 400 units just like that. The result? An asset bubble.
Economists worried this bubble far eclipsed the one we saw in the United States housing sector back in the 2000s. To put this in perspective, at the peak of the US housing boom, investors put in $900 billion in a year. In a year ending in June in China, investors had invested some $1.4 trillion.
It would be wrong to say the market did not take a breather after the coronavirus outbreak. But it was just a breather. Urban housing prices in China were 5 percent higher in June 2020 year-on-year.
But all this seems to be falling apart now.
Why is the boom turning to bane?
Beijing is trying to cool its housing market. It has tightened policies to limit overbuilding, curb debt, and preserve cash. The government doesn't want the prices to rise as it goes against its recent "common prosperity" drive. The drive is trying to address inequality between the middle and higher classes, also seen when it clamped down on internet companies and tuition firms.
These rules have exposed the fragility of Chinese developers who enjoyed a boom on the back of a business model that worked on taking debt and building houses.
China's property major Evergrande Group has already reacted to these curbs by defaulting on some important payments. But its impacts are proving to be far-reaching.
In trying to cool down the property market, China's growth could slow down. This sector accounts for about one-fourth of China's gross domestic product (higher than the US). If these curbs tighten, China's growth can decline from 6 percent to 3-5 percent in coming years, a report in the Wall Street Journal said.
The impact
China's international junk-bond market has borne the most brunt of this fallout. Junk bonds carry a higher risk of default than most bonds issued by governments and companies.
In the last six months, a  sell-off in this market has wiped off a third of investors' wealth.
Plus, as the crisis worsens, companies will control building activities and banks will refuse to finance as they restructure broken balance sheets. Chinese households will grow wary of taking new mortgages.
The household debt has already risen from $2 trillion to over $10 trillion last year. As the incomes are rising slowly in comparison, households would take a backseat if the worst-case scenario becomes a reality.
Oxford Economics analysts said they expected China's property downturn to be "contained" but added that "with shifting demographics, high numbers of empty apartments, and some big property developers being heavily over-leveraged, China’s huge property sector could crash more heavily".
One, it could initiate a massive domino effect among the builders, the signs of are showing in the economy. Experts say every company that says it cannot repay debt makes it more likely for others to join their ranks, Aayush Sonthalia, a portfolio manager for emerging markets told Axios.
This distress could spread to parts of global markets like commodities and raw materials via import-export channels, as demand for constriction materials, automobiles, and machinery drops.
Beijing's confrontation has also impacted the millions of people who work there, sending shockwaves through the economy. It is resulting in declining housing sales and a construction slump. Which is further impacting auto and retail sales. So if China buys less steel, it could further impact the global economy.
As China's domestic demand drops, economies that have the most exposure would hurt the most. Economies like Chile, Brazil, Australia, Korea, Taiwan, Malaysia, and Vietnam have the most exposure to their markets.
The turmoil in the sector has also drawn caution from the US Federal Reserve.
The US Federal Reserve warned earlier this week the troubles of the Chinese property sector can spill over to the US financial system.
"Stresses in China's real estate sector could strain the Chinese financial system, with possible spillovers to the United States," it said in the latest financial stability report. It pointed to the size of the Chinese economy and global links.
A crunch in the Chinese property market could result in unemployment, send the stocks plunging, and lead to deflation. All of these factors could pinch the global trade channels because China will have to eventually cut trade with other countries to some extent, a report in CNBC mentioned. China is intertwined with the global economy and a crash there could bleed into other countries, it said.
However, the report maintained a fallout of this level is unlikely. The chances of China stemming the containing the crash is high, but the country needs to act fast as it is hurting investor sentiment.
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