Once upon a time, in the world of finance and economics, there existed a common theme that haunted both Chinese developers, Kenyan state-owned enterprises, and countries around the world - the perils of debt. Let us embark on a journey to explore the challenges faced by these entities and the urgent need for comprehensive economic planning.
In China, the real estate market was in turmoil as developers struggled with mounting debt. Country Garden Holdings, a prominent Chinese developer, found itself in a precarious situation when it defaulted on a US dollar bond. This marked the first time the company had ever faced such a predicament. The failure to pay interest on the note within a grace period triggered an event of default, leading to potential restructuring. The Chinese authorities, in their quest to revive the real estate market, were grappling with the aftermath of a builder debt crisis that had persisted for four long years.
Meanwhile, China's regional banks were also facing their own debt crisis. S&P Global Ratings warned of a potential capital shortfall of $300 billion due to a deepening local government debt crisis. These banks had significant exposure to local government financing vehicles (LGFVs), with some banks at risk of falling below the minimum regulatory capital adequacy ratio. The banks with concentrated exposure in resource-constrained regions, particularly in lower-tier cities, were expected to be the most affected. While provincial governments attempted to contain systemic risks by issuing special refinancing bonds, the scale of local government debt remained significant.
China's debt problem extends beyond the real estate and banking sectors. A recent report from Bloomberg reveals that China's local government debt is even bigger than feared. This debt problem threatens to be a drag on the world's second-largest economy for years to come. The report highlights the similarities between China's debt situation and Japan's debt problem in the early 1990s. Japan's debt problem was worse than advertised, and economic growth didn't solve it. The fear is that China may face a similar fate if the debt issue is not effectively addressed.
China's property crisis is impacting small banks in low-growth provinces, as bad debts to developers erode their finances. Large national banks have expressed positive signs on demand and the direction of the economy. Northeastern institutions in China are experiencing sharp increases in bad loans to developers. The pressure on banks in China's northeast is acute as the country grapples with a prolonged real estate slump.
China's measures to tackle the property crisis are scrutinized by global investors. The slump in the property market has weighed on economic growth and led to a liquidity crunch for developers. Investors analyze government statements to determine if the measures are sufficient to end the slump. China's benchmark CSI 300 Index and Hong Kong's Hang Seng Index were the worst performers last year. The property crisis has been ongoing for four years.
A panel of top executives speaking at Mingtiandi's Hong Kong Forum emphasized that consumer sentiment will be key to China's property market recovery. Despite favorable fundamentals such as low borrowing costs and high savings rates, the market remains fragile as consumer sentiment has yet to rebound. Once consumers feel confident in purchasing homes or starting businesses, the economy will improve, leading to a recovery in the real estate sector. Transactions are still happening in mainland China, mostly executed by domestic investors, unlike markets such as Australia, the US, and the UK. The panelists highlighted logistics assets and the rental residential sector as pockets of opportunity in China's property sector. They also mentioned the growth of new e-commerce platforms, the electric vehicle industry, and green infrastructure projects as potential areas for investment. Overall, the panelists emphasized that China remains an important market for real estate investment despite the current lack of positive sentiment.
China's new housing construction is declining, indicating a potential stabilization of the property sector. However, the clean-up of bad assets is still needed to avoid Japan-like stagnation. New home starts in China fell 63% from their peak, and the International Monetary Fund estimates fundamental demand for housing in China to average 950 million square meters over the next 10 years. Real estate investment, which has been declining steeply, may be close to finding a floor. However, analysts believe that the property sector will stabilize at 40-50% of its peak levels and will not return as a driver of growth. Prices have fallen, and the negative financial spillovers will continue. China has not recognized losses early on, similar to Japan's response to its crisis. The government aims to stabilize the property market but does not intend to prop it up. China introduced a new support package for the sector, but comparisons with Japan's lost decades persist. The stock of unsold homes on the balance sheets of Chinese developers is still significant, and eventually, the losses will have to be recognized. Local governments may suffer a similar fate to Japanese banks and require recapitalization, leading to a longer and more protracted adjustment. Overall, China's housing prices are not expected to reach higher levels on average, except in tier 1 cities like Beijing and Shanghai.
China's economy is experiencing a flailing real estate market, a high debt burden on local governments, and 30 years of record low foreign investment levels. Major organizations are diversifying their operations and reducing their exposure in China. China has historically responded to economic downturns by exporting its way out of trouble, but the global economy has changed. China flooding the market and driving down demand and prices is seen as a threat to the global world economy. However, some believe that China is reshaping itself to new industrial and economic conditions, with continued investment in African nations and the Belt and Road Initiative. A trade war with China would have far-ranging effects, as China is still the top trading partner of over 120 countries.
In Hong Kong, the property market has suffered a significant downturn over the past five years, erasing at least HK$2.1 trillion ($270 billion) in real estate value since 2019. This slump, the longest since the SARS crisis, is driven by rising interest rates, financial-sector job losses, and geopolitical tensions. Factors such as the 2019 pro-democracy protests, Beijing's crackdown, and the impact of Covid-19 have exacerbated the decline. Property tycoons have seen their net worth shrink, and homeowners face the prospect of selling at a loss. The commercial real estate sector is also struggling, with office vacancies and falling rents. Hong Kong's government is attempting to revive the market through policy adjustments and talent programs, but significant challenges remain.
Chinese social media users have expressed discontent about the nation's economic downturn following a spate of violent attacks. A stabbing incident in a Shanghai metro station became a top trending topic on social media, with users speculating on the attacker's motive. The public reaction highlights growing fears over China's economic downturn, particularly in the property market. Protests over the economy, especially the housing crash, have become more frequent. Similar reports of violent attacks have been reported across China. Chinese authorities are aware of the link between economic changes and rises in violence. Mental health issues, compounded by economic pressures, are seen as contributing factors to acts of random violence.
Ratings agencies S&P Global and Moody’s were criticized at a US congressional hearing for failing to reflect the risk posed by China’s local government financing vehicles (LGFVs) on global financial markets. California Democrat Katie Porter highlighted the challenge caused by China’s property market downturn for LGFVs, which borrow on behalf of provinces and municipalities to finance infrastructure projects. Porter compared the situation to the global financial crisis of 2007-2008, warning that when long-term urban leases expire in the next five years, there will be a glut and leases won’t be as valuable, potentially crippling the bond market. China’s home prices saw their steepest decline in close to a decade in May, and new home sales by the nation’s top 100 developers dropped by an annual 33.6 percent. Pimco estimated that Chinese LGFV debt quadrupled to 55 trillion yuan ($7.6 trillion) in 2022 from 13.5 trillion yuan in 2012. S&P Global downgraded its projections of new home sales for 2024, citing concerns about homebuyer confidence and demand. China's ongoing property crisis has raised concerns about a potential overseas spillover. Analysts believe that a bond default or financial stress on local governments weakened by China's property market slowdown could have downstream effects on resident foreign companies and potentially spread to other financial markets. However, the likelihood of such a spillover is considered low because the problem is primarily contained within China's borders and the central government is implementing various solutions. The US Congress hearing on China's property crisis further highlighted the potential risks, with Congresswoman Katie Porter comparing the situation to the global financial crisis of 2007-2008. The collapse of highly leveraged debt-backed financial instruments in the US sparked that crisis. In China, rules aimed at curbing speculation and overcapitalization by developers have led to defaults and disrupted property values. The property slump has also affected local governments' revenue from land sales, reducing their ability to invest in infrastructure projects and impacting jobs, consumption, and retail. While a financial or debt crisis is unlikely, local government financing stress could negatively affect local economies, including foreign businesses, by reducing support and consumer demand. Domestic banks, including the four largest state-owned institutions, may also be impacted if they need to restructure loans to local government financing vehicles (LGFVs). However, severe spillover scenarios are considered unlikely. From an overseas perspective, default risks are low because onshore debt is semipublic and denominated in yuan, while the offshore debt that will mature this year is a relatively small amount. The central government has already taken measures to reduce the risk of destabilizing defaults by launching a cleanup of LGFVs and allowing local governments to swap high-interest debt with lower-interest bonds. Overall, financial markets have priced in property downturn risks, and central government measures have been effective in preventing large-scale defaults. Some individual offshore investors are not concerned about a spillover. They believe that the Chinese property market is stabilizing with government support, and the large state-owned banks are expected to withstand the pressures with strong sovereign support if needed.
Hong Kong's economy has faced challenges in recent years, including pandemic restrictions, a miserable stock market, stagnant property market, and a sharp fall in global rankings. However, there have been some positive developments, such as Hong Kong's improved rankings in competitiveness and airline ratings. Despite these positive signs, there are still persistent challenges, including a loss of trust in the government, a decline in headquarters operations, and a fragile property market. While there is talk of an economic recovery in the second half of the year, it remains far off and green shoots remain fragile. The article warns against underestimating the challenges that Hong Kong still faces.