The long days of summer are proving to be rather too long for the government in Beijing. In an attempt to stabilise the faltering real estate market, the authorities announced earlier this week a modest decline in interest rates that was underwhelming in scale and intent.
Those who recall the bad old days in which the west was buffeted by successive crises such as those involving Northern Rock, Bear Stearns and Lehman Brothers will recognise the futility of lower interest rates in stemming systemic problems in real estate and finance when the problem has nothing to do with interest rates being too high. And so it is in contemporary China, where the government is battling to stabilise an unstable economy.
It is clear that China’s economy is flailing. The yuan exchange rate is under pressure, and the authorities may be hard pushed to prevent people and firms trying to get money out of China despite tough regulations on the outflow of capital. Stock prices, which, to be fair, are only weakly associated with the economy, are at their lowest level since the end of 2022, but they reveal a paucity of confidence among Chinese households, investors and private firms in a deflationary environment.
The proximate cause for this troublesome state of affairs is the real estate market. Transaction volumes are down heavily and the reported fall in home prices seems, if anything, to be gaining momentum. During the last few days, the property developer at the heart of the crisis, Evergrande, filed for bankruptcy protection against creditors in New York, Hong Kong and the Cayman Islands. While a liquidity crisis has gripped it and many of its peers, another big firm, Country Garden – hailed a year ago as a model corporate citizen – has defaulted on some of its international bond obligations, and now as a penny stock, is struggling to regain market confidence.
China’s malaise is not the result of zero-Covid policies, nor is it a cyclical phenomenon that will fizzle with the passage of time and additional policy easing. It is fundamentally about a faltering of the country’s economic development model, featuring the first real estate bust since a former housing-welfare system was transformed into the world’s biggest, and for a while most important, property market.
The boom began long before the Covid pandemic, and for many years the state nurtured it with lax property regulation and successive rounds of generous financing of construction and infrastructure whenever the economy needed a lift. With banks, households and property developers knowing the government was always on their side, they behaved financially as though property prices and speculation were a one-way bet.
Yet, as we also found out in 2008, when the music stops all participants behave like a herd as they rush for the exit. And this is what China faces now, but with the addition of terrible demographics. Housing construction in China before the pandemic was running at levels that were about 30% greater than those that could be warranted by predicted lower levels of household formation and numbers of first-time buyers. Overbuilding and vacancy rates in hundreds of smaller towns and cities are chronic.
The real estate sector, then, is going to contract significantly from a weighty 23%-25% of GDP, and the government can only really try to manage that decline, if possible. Given the depths to which transactions have fallen there might be room for a short-term recovery if or when confidence returns, for example if the government announces soon some fiscal assistance for housing. Yet, the medium-term trend looks cast in stone, and if home prices continue to drop, it could prove hard to prevent damage: to property supply chains, for example in construction and commodities, to banks, and even to social stability.
As autumn looms, China may try to get the economy back on track, and there will soon be an important five-yearly party gathering, the third plenum (of the 20th party congress), often known for setting out strategic economic priorities. It is a moot point, though, if Xi’s China has the political will to address a raft of problems that require liberal or market reforms. These would include changes to the tax structure, social welfare, local government debt, political governance, productivity, and, above all, various forms of income redistribution from the state to individuals and private firms to encourage more robust consumption. Such moves do not sit comfortably with the Leninist hew of Xi’s China, which is now crossing a river where the stones are too deep to feel.
