Finance & Economics

Real Estate Crisis to Stop Development of China’s Economy for Years

The steady growth of the Chinese economy, which is a historical example of a process that has a high level of sustainability and demonstrates impressive speed, for several decades had been largely due to such a factor as the active development of the real estate sector against the background of population growth and large-scale urbanization, but at present this base of constantly improving prosperity is not effective.

Real Estate Crisis to Stop Development of China's Economy for Years

The real estate market accounts for up to 30% of the total structure of China’s economic system. About two years ago, a crisis began in this significant sphere, which continues to this day and shows no signs of an imminent change of vector from negative to positive. China’s real estate sector found itself in a situation of total decline after local authorities restricted the borrowing of developers. Last year, for the first time in a decade, investments in this sphere fell.

The authorities have not yet made a single statement that would contain hints at at least the likelihood of government measures to remedy the situation in the real estate sector. Experts believe that the absence of Beijing’s substantial plans to save the most important industry for the country’s economy signals the continuation of the crisis. The sensitivity of the problem, in this case, lies in the fact that the negative state of affairs is not a situation that exists exclusively within the industry. This means that the crisis in the real estate sector is a kind of barrier to the growth of the Chinese economy in a global sense over the next three to five years.

Alicia Garcia-Herrero, chief economist at Natixis for the Asia-Pacific region, believes that for Beijing, the way out of this situation is to slowly and painfully adapt. According to her, the adjustment has already begun, but this process will last several years. Alicia Garcia Herrero noted that the country must match the supply of housing at a low level of demand, which continues to decline amid an aging population.

This task is very difficult from the point of view of feasibility prospects. Last month, the former deputy head of the National Bureau of Statistics said that China’s total population of 1.4 billion people is not enough to populate all the empty apartments in the country.

The Government, despite refusing to actively intervene in the negative situation, is still taking certain measures aimed at improving the situation in the real estate sector. The authorities have introduced a so-called stock unloading policy to reduce oversupply. In this case, slowing down the pace of land sales in cities and encouraging developers to reduce the cost of housing in order to stimulate demand are identified as the main measures.

Alicia Garcia-Herrero says that the absorption of excess capacity in the real estate sector will be a factor of negative impact on the growth of the Chinese economy. According to her, the country will reduce the growth rate by about 1.5% every year. She believes that this will last at least until 2026.

The World Bank has lowered its forecast for China’s gross domestic product (GDP) growth for 2024 to 4.4% from 4.8%. The adjustment of the vision of the prospects of economic dynamics was explained by such internal circumstances as the weakness of property, the aging of the population, and increased debt.

The International Monetary Fund expects China’s economic growth to slow to about 3.5% in the medium term from about 5% in 2023. The experts of this organization explained their forecast by a decrease in the rate of productivity in the country and demographic problems. The IMF claims that the economic situation in China will improve if the authorities strengthen incentive measures and introduce reforms.

For many years, Chinese developers have adhered to a simple business model, which provided for the sale of apartments before commissioning. Local regulators introduced this principle of commercial operation in 1994. This was done in order to meet the growing demand for real estate during the period of intensive urbanization that began after the entry into force of market-oriented reforms. Developers were enriched at an incredible pace, and the owners of companies of the appropriate profile became the richest people in the country.

Until the early 2020s, the real estate sector was something like a space of abundance in terms of profitability. But about three years ago, the period of big money for representatives of this industry began to gradually turn from objective reality into the past, which is getting worse and worse consistent with what is happening. The Chinese government has taken measures to combat excessive borrowing in the real estate sector. Beijing explained this decision with fears of financial instability. Also, the measures were partly due to an attempt to contain the growth in the value of real estate and reduce the risks associated with increasing debt.

The actions of the authorities have exacerbated the lack of cash from developers such as Evergrande, which was eventually forced to default on its obligations to debtholders in December 2021. This event has become a kind of starting point for the industry downturn. There were expectations that the mentioned developer would be restructured, which would allow to correct the situation, but this did not happen. Last week, the founder and chairman of the board of Evergrande, Xu Jiayin, was detained on suspicion of committing crimes. The authorities did not disclose what the detainee was suspected of. This event was very bad news for investors who hoped that the developer would reach an agreement with its creditors in the near future.

The detention also increased concerns about the future of Evergrande. Currently, the developer has unpaid debts of more than $ 300 billion and hundreds of thousands of unfinished apartments throughout China. The potential liquidation of the company may undermine the already unstable confidence in the real estate sector. If this happens, the possibility of reviving the industry will be something like a blocked function for the coming years.

Official data indicate that in 2020, the number of new construction projects in China, measured by area, decreased by 2%. A year later, the rate of negative dynamics increased to 11%. Last year, the number of new construction projects decreased by 39%. This dynamic indicates that the deterioration of the situation is not only continuing but is also scaling up.

Against the background of the negative state of affairs in the economy, Beijing is forced to look for new sources of growth. Last month, Chinese President Xi Jinping announced the need for a new type of industrialization, in which green technologies are of particular importance. Analysts at Capital Economics believe that this action plan will not lead the country to significant results in the near future. Mark Williams, Sheana Yue, and Zichuan Huang, in an analytical note released last week, stated that within the framework of the mentioned concept, there are no sectors that could compensate for the decline in the real estate market.

Strategically developing industries, including advanced materials and tools, and environmentally friendly energy products, provided just over 13% of China’s GDP in 2022 by the end of last year. These data confirm the opinion of Capital Economics analysts.

At the same time, the sale of land to developers accounted for more than 40% of local government revenues for a long period until 2021. In 2022, this figure was fixed at 37%.

The new industrialization plan of the head of the People’s Republic of China is more similar to attempts to conceptualize Beijing’s actions aimed at ensuring technological sovereignty and competition with the West. According to analysts at Capital Economics, in this case, there are no solutions that can stimulate GDP growth. They also believe that the use of resources for technological confrontation will provoke a weakening of the pace of economic development.

Analysts from Stanford University and ASPI say that the fundamental restructuring of the Chinese economy requires the development of new industries, strengthening rental markets, and increasing productivity.

As we have reported earlier, China to Make Its Business Environment More Friendly for Foreign Companies.

Serhii Mikhailov

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Serhii’s track record of study and work spans six years at the Faculty of Philology and eight years in the media, during which he has developed a deep understanding of various aspects of the industry and honed his writing skills; his areas of expertise include fintech, payments, cryptocurrency, and financial services, and he is constantly keeping a close eye on the latest developments and innovations in these fields, as he believes that they will have a significant impact on the future direction of the economy as a whole.