China’s Country Garden reaction: Mirabaud investment director

by | Aug 15, 2023

Following the dramatic fall of Evergrande in 2021, news that Country Garden has fallen behind on its bond payments has sent shockwaves through global markets. John Plassard, director at Mirabaud Group, contends that while this is clearly bad news for the international economy, fears of systemic risks have been overblown. Below, Plassard breaks down the crisis and attempts to answer why – despite being the largest asset class in the world – Xi Jinping is not likely to intervene.

John Plassard comments on the potential bankruptcy of Country Garden:

The potential bankruptcy of Country Garden is very bad news, as it could have negative implications for many parts of the Chinese and international economy. However, to think that this is a systemic risk would be a mistake. The Chinese government is fully aware that the country’s property sector is the world’s largest asset and will do everything in its power to save it… after punishing speculators as it has done in the technology sector.

One of China’s largest property developers has reported that it burned through up as much as $7.6 billion in the first half of the year, exacerbating the crisis in the country’s property sector. 

Country Garden warned investors in a filing to the Hong Kong stock exchange on Thursday that it was likely to record a loss of between 45 and 55 billion Chinese yuan (around $6.2 billion and $7.6 billion) for the six months to June. This compares with earnings of around 1.9 billion yuan ($264.3 million) for the same period last year. Earlier this week, Country Garden fuelled concerns by missing two bond payments.

The company stated in its filing that it would “consider adopting various debt management measures”, without giving further details, and that it would rely on a newly established task force to “address” its challenges. This announcement is obviously very bad news for the entire financial community.

To put things into perspective, the Chinese property market is the largest asset class in the world, with an estimated market value of around $62 trillion. It is larger than the US stock market.

How healthy is the Chinese property market?

According to various estimates, property investment accounts for between 25% and 30% of China’s total fixed-asset investment in construction, property services and the supply of goods, as well as in related sectors such as energy, finance, equipment, transport and storage. 

The property sector as a whole is estimated to account for almost 10% of employment in China, almost 20% of local government tax revenues. 

Finally, home loans accounted for 28.9% of all bank lending at the end of 2020. The value of new home sales by the 100 largest property developers fell by 33.1% year-on-year to 350.4 billion yuan ($49 billion), according to preliminary data from the China Real Estate Information Corp. This was the second consecutive decline, following four months of increases. Sales fell by 33.5% month-on-month. 

The collapse in transactions is a major blow to developers, who need cash to ease a years-long credit crisis that shows no sign of abating. 

With regard to the vacancy rate in China, according to a report by the Beike Research Institute, the country’s residential property vacancy rate was 12% on average in 28 major cities in 2020. Another report from the journal Chinese Geographical Science estimated that the average vacancy rate in mainland China was 12.1% in 2018. 

However, vacancy rates can vary considerably between regions, cities and housing types. For example, the Beike report found that the lowest (15%) and highest (24.3%) vacancy rates were recorded in Shenzhen and Nanning, respectively. The report also revealed that the vacancy rate was relatively low in the eastern coastal regions, while it was high in the north-eastern and western inland regions. In addition, the report shows that the vacancy rate had a gradual upward trend as the level of the city fell. 

Many factors can contribute to the high vacancy rate in the Chinese property market, such as speculation, investment, migration, urbanisation, government policies and social norms.

Some analysts have warned that the high vacancy rate poses a risk to China’s economy, society and national security, as it can lead to wasted resources, social inequality, financial instability and environmental degradation. Others argue that the high vacancy rate is not necessarily a problem, as it may reflect potential demand for future urbanisation and improved consumption. 

For 2023, according to a report by CBRE China, the vacancy rate for residential properties in China is expected to average 12% in 28 major cities. This is the second highest rate in the world after Japan, and higher than the US vacancy rate of 11.1%, according to the report.

Why doesn’t the Chinese government intervene (anymore)?

The logical question for the financial community today is why the Chinese government is not intervening “more” in the Chinese property sector, when it knows full well that there is a major “economic risk” if developer bankruptcies continue. This could even jeopardise the government’s target of 5% annual economic growth. 

The answer is “quite simple”. President Xi Jinping is totally against property speculation and is doing everything he can to break the momentum of property developers, who have benefited from “zero-interest” money for many years. 

President Xi believes speculation is harmful to China’s economy, society and national security. His anti-speculation policy is based on several arguments:

  1. Speculation is driving up property prices and making it more difficult for ordinary people to own their home. This creates social inequalities and discontent, which could threaten the stability and legitimacy of the Chinese Communist Party. 
  2. Speculation increases the risk of a debt crisis and financial collapse, as the case of Evergrande shows. A collapse in the property sector, which accounts for around a quarter of China’s GDP, could have serious consequences for the national and global economy. 
  3. Speculation also undermines President Xi’s vision of building a “prosperous society” by 2035 and a “great modern socialist country” by 2050. To achieve these goals, President Xi must ensure that China’s economic growth is sustainable, balanced and inclusive. 
  4. The speculation is also at odds with Xi’s ideology of “socialism with Chinese characteristics for a new era”, which emphasises the CCP’s role as leader and guardian of the nation. Xi wants to assert party control over all aspects of China’s governance, including the market and the private sector.

To prevent this part of the Chinese economy from collapsing, at the end of July 2023, the Communist Party’s main decision-making body undertook to optimise and adjust policies relating to the property sector. The Politburo also referred to President Xi’s mantra that houses should be lived in rather than speculated on. 

The Chinese authorities are also trying to remedy the financing difficulties faced by developers. To “keep their heads above water”. In July, regulators extended loan relief to builders to ensure the delivery of homes under construction. The securities regulator has committed to guaranteeing the financing of developers on the debt and equity markets.

Why isn’t real estate driving China’s growth?

There is often (always?) confusion about China’s property sector. Economists usually say that China relies on the property sector as an engine of growth. But this is not true. 

The Chinese property sector is not an engine of growth for the Chinese economy, but a consequence of growth. The sector has been riding the wave of China’s remarkable economic boom, the result of structural economic reforms that have boosted productivity growth. The unique characteristics of the Chinese economy have further fuelled the expansion of the Chinese real estate sector and led it to become exceedingly important. 

A report by S&P Global points to the Balassa-Samuelson effect, a theory developed by economists Bela Balassa and Paul Samuelson to explain why price levels are higher in advanced economies than in developing ones, as an explanation for the trend in China’s property sector. 

The rapid increase in housing prices in China is therefore due to the high and constant growth in productivity of the Chinese economy, triggered by the policy of reform and opening up launched in 1978. Sustained urbanisation has also supported the expansion of the housing market. In 1998, when China’s social housing system was dismantled, 33.4% of the population lived in urban areas; by 2020, 63.9% of the population was expected to be living in cities.

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