Contagion "so extreme": China's largest property developer reports 70% profit loss as housing bubble threatens to raze middle class -- China Boss update 8.19.22
Update
What happened.
“China’s deflating property bubble is imperiling the world’s second-largest economy with effects that could ripple for years,” Wall Street Journal’s Rebecca Feng and Cao Li wrote last week.
Feng & Li, WSJ:
Home prices are dropping in many cities after a long period of increases, data from Chinese real-estate developers and official statistics show. Sales of apartments nationwide by the country’s largest developers have slumped annually for 13 consecutive months, according to industry-data provider China Real Estate Information Corp.
The Financial Times also reported that China’s largest property group Country Garden announced its “first-half profits fell as much as 70 per cent in the first half of the year, as the country’s largest real estate group by sales was drawn into a crisis that has raged through the heavily indebted sector.”
FT:
Country Garden, which lost its last investment-grade rating after Fitch downgraded it to junk status on Tuesday, cited a market downturn, the effects of the coronavirus pandemic and foreign exchange losses for the fall in earnings. Unlike a growing number of its highly leveraged peers, Country Garden has not defaulted on its debts.
Nevertheless, Alicia García Herrero, chief economist for Asia-Pacific at Natixis, told FT that the developer “was suffering from worsening investor sentiment towards the sector” who had “fears of falling prices as demand wanes and new apartments remain uncompleted.” “Now even Country Garden couldn’t basically proceed with presales for new projects because the contagion is so extreme,” she said.
Why it matters.
A stress fracture on China’s already-weakened economy
“The damage, which is spreading across industries from building materials to real-estate services and is causing loan losses to pile up at banks, will be difficult to repair quickly,” Feng and Li said.
Feng & Li, WSJ:
The bigger risk is to China’s economy. Bank of America research analysts noted in a report last month that approximately 9% of the housing floor space that was presold in 2020 and 2021 risks not being completed on schedule because of developers’ financial troubles, affecting roughly 2.4 million households.
“Such incidents, if left unchecked and spread out, could dampen market confidence, hit property sales and investment, weigh on economic growth, and cause social instability” right before an important twice-a-decade Communist Party congress later this year, the analysts wrote. The closely watched conclave is expected to see Chinese President Xi Jinping secure an unprecedented third term in power.
China recorded a 0.4% expansion in second-quarter gross domestic product from a year ago, its worst economic performance since the start of the coronavirus pandemic. While much of the slowdown was due to Covid-related lockdowns and restrictions, a 7% contraction in the real-estate sector contributed to the weak output.
Rhodium Group’s China Markets Research Director Logan Wright told WSJ that his team has “‘never seen a property market slowdown of this size and severity’” in China,” and that there wasn’t a whole lot that the Chinese government could do “to turn things around and offset the economic impact of the property downturn.”
Central policy-makers haven't offered an industry-wide bailout, preferring instead to delegate “the concerns of home buyers” to local governments who are “tasked” with “making sure that unfinished property projects are completed." But many cities, counties, and provinces are, themselves, riddled with debt, and it remains unclear how or if they’ll be able to help.
WSJ:
Few cities besides Zhengzhou have said how they intend to fix the problem. Before the recent mortgage protests, many city governments had tried to help developers revive sales by lowering down payments, reducing interest rates, offering cash subsidies and removing restrictions that had prevented people from buying multiple homes.
Betty Wang, senior China economist at ANZ, an Australian banking group, said that in the absence of clear guidance from top policy makers, the Chinese property sector will continue to downsize for some time. “The market has already had a hard landing,” she said, adding: “It will be very difficult for many developers to recover from this downturn.”
Huge debt threatens many in China’s middle class who say they can only “spend less”
“China’s deepening property bust is sending shock waves through the nation’s 400-million-strong middle class,” and “many Chinese homeowners are slashing spending, postponing marriage and other life decisions, and, in a growing number of cases, withholding mortgage payments on unfinished homes,” Bloomberg last week said.
Bloomberg:
In China, where disposable income per capita is just a fraction of that in the US, it often takes years of savings to afford an apartment, which normally costs a few million yuan in main urban centers. Young couples typically rely on parents and grandparents to help finance purchases -- the so-called “six wallets.”
Li, a technology firm worker who has taken a 25% pay cut this year, now uses a third of his salary to make a monthly 4,000 yuan mortgage payment on a stalled Evergrande development in Wuhan. This month, he joined about 5,000 others in a boycott to push the local government and the developer to restart construction on the project, which is supposed to house 39 residential skyscrapers.
The 26-year-old says he’s “terrified” about his prospects and is afraid to start a relationship because he’s unsure he will own property -- seen as a requirement for marriage.
Much of China’s middle class appears to be hunkering down to hold onto what they can rather than spending South China Morning Post’s He Huifeng says. She interviewed several individuals who also said they were anxious over their finances.
He, SCMP:
“From international and domestic news, we have seen that global commodity inflation is significant, and it will definitely affect China’s oil, natural gas and grain prices in the second half of the year,” said Gong Wentao, an independent investor in Shenzhen’s property market and the mainland’s stock market.
“But for ordinary people, we still believe in the ability of the Chinese government to stabilise basic prices … Such high inflation rates in the West will certainly not happen in China.
“Meanwhile, at present, China’s housing prices, rents and incomes are generally stagnant, with growing news of people being laid off. All we can do is spend less, invariably, no matter what kind of incentives are launched. This is equivalent to the eve of a depression, which is really scary.”
That won’t help China’s perennial domestic consumption problem which may further weigh on growth, according to experts.
Michael Pettis, Carnegie Endowment:
There’s no mystery as to why the Chinese consumption share of GDP is so low. Chinese households retain a very low share—in the form of salaries and wages, other income, and transfers—of what they produce, so they are unable to consume more than a low share of what they produce. Beijing’s new common prosperity policies focus on redistributing income from the wealthy to the poor and the middle class, but even if the program is successful, this will only help at the margins.
That is why there is also no mystery about how to sustainably raise the consumption share of GDP: Chinese households must retain a larger share of what they produce, which of course also means that some other sector of the economy—either businesses, the government, or foreigners (although this last category is too small to matter)—must retain a reduced share.
With businesses in China retaining roughly the same share of GDP as in other countries, it would be costly for Beijing to force businesses to absorb the extent of the necessary transfer, which leaves only the government sector (mainly meaning local governments). The only way to rebalance consumption in China meaningfully and sustainably, in other words, requires substantial transfers from local government to households.
Watch on YouTube.
****
Have a great weekend.