FXP - China Property's Slump Further Reduces Growth Prospects
2023-11-18 03:55:00 ET
Summary
- China's property market is struggling with unresolved debts and slow sales, leading to economic deceleration.
- Buyers are reluctant to invest in unfinished homes due to spreading defaults and a legal system unwilling to restructure debt.
- The challenges in the property sector are impacting other sectors and worsening the economic slowdown in China.
By Sean Jutahkiti, CFA
The China property market is grappling with unresolved debts and anemic sales, creating ripple effects across sectors and worsening economic deceleration.
Despite China’s first nationwide property easing measures since 2015, housing sales in China continue to languish. Even investment grade issuers are trading in distressed territory now. The persistent inability to boost market confidence underscores the deep-seated issues in a sector still struggling to resolve accumulating bad debt two years after Evergrande’s default.
China’s households play a significant role in directly financing property construction by paying upfront for unfinished homes. As a result, about a third of developers' liabilities are owed to homebuyers. Given spreading defaults and a legal system unwilling to restructure debt to reboot the sector, buyers are reluctant to invest in unfinished homes, despite having saved significantly during the pandemic and property downturn. This withdrawal of interest-free credit to developers has, in turn, disrupted the property investment chain that supports local government revenues and property construction.
The challenges facing the property market are reverberating across sectors and worsening the economic slowdown. Local Government Financing Vehicles ('LGFV') face increasing credit risk due to their reliance on land sales and the use of real estate as collateral to sustain heavy debt loads. LGFV debt accounts for about 12% of banking assets, a significant amount compared to the 5% attributable to developer debt. With depressed property sales, the backlog of unfinished projects could keep property construction going until mid-2024. After that, we could see a steep decline in construction activity, further slowing economic growth and putting pressure on credit creation. However, although a decline in bank profitability is inevitable, risk-averse households are likely to keep most of their savings in deposits, ensuring ample liquidity in banks and mitigating the risk of a full-blown banking crisis.
In response to these challenges, China has pledged to establish a long-term mechanism to manage debt risks associated with local authorities. It has also shown a willingness to expand borrowing at the central government level, although the size seems limited in scope and the specifics of these measures remain unclear.
In conclusion, the ongoing struggles in the property sector are likely to continue exerting intermediate-term pressure on China's economic growth. The interconnected nature of the property sector with households, local governments and the broader financial system means that the impact of these challenges is widespread. This underscores the urgency of effective measures from the government to address these challenges, and the end game could well be a real estate sector dominated by utility-like State-Owned Enterprises.
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China Property's Slump Further Reduces Growth Prospects