China faced a real estate bomb

In 2022, the Chinese economy is expected to grow by 3.3%, the IMF estimates in its latest forecasts published in July. “The lowest rate in over forty years, if we exclude the beginning of the Covid-19 crisis”points out the Fund, which still expected growth of 4.4% … in April!

Revised downward prospects both for the “zero Covid” strategy led by Beijing and for the slowdown in the real estate sector. The setbacks of promoter Evergrande, revealed a year ago, are only the sunken face of a more structural slowdown in this key sector for the Chinese economy.

“In the 1980s, the end of employer housing policies, characteristics of the socialist model, opened the sector to private actors”remember Thomas Carre, Lenig Chalmel, Eloïse Villani and Jingxia Yang, four specialists in the Chinese economy, authors of a note on the subject published by the Directorate General of the Treasury.

The growth of the Chinese population, the increase in urbanization – which increased from 36% in 2000 to 61% in 2020 – and the lack of investment opportunities outside the real estate sector for Chinese families have stimulated investment in the sector. for several decades.

“In total, 90% of Chinese families, both urban and rural, own a house and over 20% of Chinese families own several properties”details the authors.

Speculation is all the easier in China as no property, wealth or inheritance tax is likely to increase the cost of owning a home.

As a result, the real estate sector now accounts for 14% of GDP and 30% when all associated activities are considered. China finds itself even more dependent on its real estate sector than Ireland and Spain before the financial crisis.

A lack of regulation

The lack of regulation of the sector has favored the indebtedness of the promoters, whose economic model is based on the “leverage effect”. As legal ownership of land is public in China, developers begin by auctioning the usage rights of local communities. Then they go “take real estate loans from banks (the rights to use the land acquired which serve as collateral), pre-sell the housing before construction and finally hand over the housing to the buyers”summarizes the note from DG Trésor.

All of this could work up to a point, which has been overcome. Simultaneous slowdowns in demographics and urbanization are holding back the demand for housing and stalling the car.

No longer being able to ignore the excesses of the sector, the authorities have tried, since the summer of 2020, to take it in hand. They established three red lines to control manufacturers ‘leverage and established relationships to limit banks’ exposure to the real estate sector.

“The brake on the real estate sector in 2020 had seemed irreversible: in its size and in the rhetoric that accompanied it, this tightening campaign stood out from the previous ones”experts say.

In the end it was nothing. Because, as the Chinese authorities use the real estate sector as an adjustment variable to meet their growth targets, they quickly turned back.

For example, when the economy overheated in 2009, they held back the sector by raising interest rates – to raise the cost of mortgages – and banning families from buying a second apartment. Conversely, when the economy slowed around 2016, Beijing loosened its grip on the real estate sector, to the point of creating real estate. “ghost city”.

“Nationally, from 1999 to 2021, the surfaces under construction were on average more than three times higher each year than the surfaces sold”count the authors who describe, apart from the most attractive urban centers (Beijing, Shanghai, Guangzhou and Shenzhen) a sharp increase in the stock of free space waiting to be sold.

A dead end for growth

Chinese power has two options. The first: to relaunch the consolidation of the sector, even if it means giving up some growth points.

Indeed, a forced slowdown in the real estate sector would have significant consequences for banks, as outstanding loans in the real estate sector represented 27% of total bank loans outstanding in 2021. It would also have consequences for local authorities. , of which 45% income depends on the sale of rights of use and on households.

On this last point, “a slowdown in the real estate sector accompanied by a drop in prices would have opposite effects”summarize the authors :

“On the one hand, this would facilitate access to housing for the middle classes [en entraînant, à terme, une baisse des prix, NDLR]but on the other hand, it would affect the behavior of owner families and reduce their confidence and consumption, as well as the political risk of dissatisfaction of the richest in a year of renewal of political elites. “

The 20And the Chinese Communist Party congress is in fact scheduled for autumn.

Second option for Beijing: prioritize achieving growth targets – “about 5.5%” for 2022, or 2 points more than what the IMF now predicts, even at the cost of increasing real estate fragility. And even at the cost of delaying the redirection of real estate investment flows to more productive and strategic sectors, such as the high-tech industry.

In the end, even this second option would be tantamount to penalizing the country’s growth because, the World Bank points out, the decline in Chinese productivity is partly explained by an increase in credit and investments in the real estate sector.

Whether it eventually explodes in the short or long term, China’s real estate bomb will surely be devastating to the world’s second largest economy.

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