CXSE - Contagion risk: How bad is the property crisis in China?

2023-08-18 05:59:37 ET

The world's second largest economy is in a predicament and the property market stands at the heart of its troubles. Construction accounts for as much as a quarter of China's gross domestic product, but real estate reverberations are shaking up confidence and many are afraid about knock-on effects for the overall economy. Housing sales, prices and investment are falling , while a deflationary spiral threatens to fuel an even bigger disaster for a country that just experienced three years of strict zero-COVID controls .

The latest: The world's most indebted property developer, China Evergrande ( OTC:EGRNF ), just filed for protection under Chapter 15 of the U.S. bankruptcy code, which shields non-U.S. companies that are undergoing restructuring from creditors. Evergrande already slipped into a liquidity crisis in 2021 following government efforts to curb speculation in the sector, and currently has around $300B in liabilities. Another Chinese developer, Country Garden ( OTCPK:CTRYF ), has also been in the spotlight after missing dollar-denominated debt payments, but the bigger fear here is that the property crisis may be expanding from the private sector to companies with state backing.

Meanwhile, China's central bank has stepped up to defend its currency following the latest series of weak economic data releases . The midpoint on the onshore yuan was set at 7.2006 against the dollar overnight, while the Hang Seng benchmark index ( HSI ) closed in bear market territory, more than 20% below its last highs in January. Problems in China might also be leading to flight-to-safety trades, with the yield on the benchmark 10-year U.S. Treasury this week surging to its highest level since 2007 .

Lost decade? The People's Bank of China has been cutting interest rates - and there has been talk about tax breaks and incentives - but many of those stimulus measures helped fuel China's rapid expansion and the real estate bubble in the first place. There are also structural issues at play, such as slowing urbanization and a shrinking population , meaning policymakers might have to prepare for an extended period of weaker growth. A "go big or go home" strategy might be the only way out of the cycle, with the government absorbing soured assets, but that could also be a challenge given deflationary risks and whether it would go far enough to restore investor confidence.

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