Chinese economy faces risk of multi-year real estate hangover

HONG KONG — China’s aggressive campaign to stamp out speculative real estate activity could slow the country’s growth rate for years to come, economists say, even if the worst-case scenario – a major housing correction with a sharp decline of house prices – is avoided.

China is attempting a controlled slowdown in the country’s real estate market – whose decades-long boom has led to uncontrollable price increases and a glut of empty apartments – in a bid to reduce financial risks and get the economy back on track. more solid foundations.

While economists generally agree that there is a need to purge the market of irrational behavior, they say the campaign will at least partially deprive China of one of its greatest sources of growth. Chinese policymakers have signaled that they recognize there will be a trade-off for economic growth, but have shown no indication that they plan to scrap regulations on developers and home buyers.

Real estate activity accounts for about a quarter of gross domestic product in China – far more than in the United States – and speculative behavior has supported employment and income collection in cities for years. Without a booming real estate market, China is more likely to experience annual growth of around 3% to 5% over the next several years, economists say, instead of the over 6% growth at which it was used to it.

“A successful campaign to make housing more affordable will come at a cost, possibly putting 5-6% growth out of reach in a sustainable way,” wrote economists from the Institute of International Finance, a global association of financial companies. Washington-based, in a recent report. report. The IIR predicts that China’s GDP will grow on average by 3% or less each year from 2022 to 2031 as its economy matures, per capita income rises, and real estate slows.

That’s lower than the average annual growth rate of 5% that China must maintain by 2025 to avoid the middle-income trap – a phenomenon in which developing economies stagnate before people’s incomes catch up with larger economies. progress – according to speeches made earlier this year. year by Zhu Guangyao, former Chinese vice minister of finance.

According to calculations by Oxford Economics, real estate and other related industries contributed 24% of China’s GDP in 2016, compared to 15% in the United States.

“There is simply no other sector or industry that can fill the void if the real estate sector is no longer an engine of growth,” said Yao Wei, economist at Société Générale in Hong Kong.

Chinese officials have long stressed the need for higher-quality growth in domestic consumption, as opposed to unnecessary investment in real estate and infrastructure.

Evergrande, China’s most indebted real estate developer, has kept global markets on alert and sparked protests in his country as he struggles to survive. WSJ explains why the corporate crisis raises questions about the state of the world’s second-largest economy. Photo: Alex Plavevski / Shutterstock

After years of rapidly rising house prices and growing debt, Chinese authorities have imposed new rules over the past year, intended to slow the market down and limit the amount developers can borrow to keep going. to develop. These measures led to a sharp drop in sales and raised concerns about a possible serious housing recession.

Many analysts say Beijing has many tools to contain the damage. Yet even a controlled decline in real estate activity will affect many people.

Private companies such as struggling developer China Evergrande Group employ hundreds of thousands of workers across the country, while also supporting construction companies and other contractors. Nearly 20% of China’s 285 million migrant workers earned income from construction-related jobs in 2020, according to data from China’s National Bureau of Statistics.

Centaline Property, a leading real estate agency in China with nearly 40,000 employees, plans to lay off around 1,000 agents in its Shanghai and Shenzhen offices as the market slows, a person familiar with the matter said. Centaline declined to comment. Real estate company agents say they earn fewer commissions, which could affect spending.

Local governments, which face limited options under Chinese regulations to increase their income through taxes and borrowing, have become extremely dependent on land sales, which are expected to slow as the real estate market cools. . In 2020, revenue from land sales reached $ 1.3 trillion, or 84% of local tax revenue that year, up from 70% in 2019 and 37% in 2015, according to data provider Wind. .

If localities cannot sell that much land in the future, it will limit their ability to invest in infrastructure, another engine of growth for China, and to pay off their own growing debts. The total debt of local government finance vehicles, a popular way for officials to obtain off-balance sheet loans, reached around 52% of China’s GDP by the end of 2020, according to Goldman Sachs calculations..

“The main source of income to pay off these debts is the sale of land,” said Houze Song, a researcher at the Paulson Institute, a Chicago-based think tank.

In the southwestern city of Beihai, where land sales accounted for 47% of total local government revenue in 2019, Wei Zhigang, director of a mid-sized developer, said average monthly sales were down by more than half from pre-pandemic levels. . Potential buyers have become more reluctant to close deals as they anticipate further price cuts, he said.

The company will no longer participate in land auctions in the city, but will instead focus on new developments in wealthier areas such as Zhejiang province, said Wei, whose company primarily sells resort properties. “Winter for us in the industry has not yet arrived,” he said. “We have to be careful. “

Lower demand for land could also reduce the amount of new credit that other businesses can obtain. More than half of the Chinese banking system’s total loans are land-backed, a popular guarantee that Chinese banks accept when making loans, said Dinny McMahon, author of “The Great Wall of China’s Debt.” .

“If land prices and real estate prices start to fall, the capacity and willingness of the Chinese financial system to grant loans will also contract,” he said.

Michael Pettis, a finance professor at Peking University, said it’s clear Beijing wants to promote higher-quality growth, but it remains to be seen whether China will be ready to put up with much lower GDP. next year, when the growth momentum in both exports and consumption are expected to stabilize.

“In the long run it’s good to stop the bubble, but in the short run it’s very painful to do it,” Pettis said. “The question is whether they will continue to try to suppress the growth in debt or will they step on the accelerator again for higher growth numbers.”

Write to Stella Yifan Xie at [email protected]

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