Courtesy of The Diplomat
In 2021, Chinese real estate developer Evergrande, the second-largest real estate group in China at the time, defaulted on its debts. This default has had catastrophic effects: various mortgage crises, subsequent defaults, and banking and capital issues have since rocked mainland China. This has left the Chinese economy in a state of panic that will have significant ramifications not only for itself but for most of the global economy. What started out as a large, but contained collapse of a real estate giant has now spiraled into a full-blown panic in the real estate sector and a panic amidst the broader Chinese economy.
Evergrande, although not alone in causing this potential economic catastrophe, was the first to fall. Overleveraged, and strained by the COVID-19 crisis, the company was dealt a final blow when Beijing placed restrictions on how overleveraged real estate developers could be. The ensuing panic by the market, and the company’s inability to continue borrowing to keep projects afloat, meant its capital chain broke down. Ultimately, this forced the company into default, filing for bankruptcy in August 2023.
With real estate comprising as much as 30% of China’s GDP, the collapse of sector giant Evergrande sent shockwaves across the nation and caused significant unrest in the housing market. This is exacerbated through the norms of purchasing a house in China, which are very different to the United States. Often, homebuyers pay for a property well before it is finished. To finance this, they take out mortgages from banks to pay the amount in full to the developer, and begin to personally pay off the mortgages before they even move in. This encourages not only speculation on the part of the buyers to pay for properties before they have the money to but also encourages the real estate developers to cut corners where they can as the profits are already guaranteed. This has led to a phenomenon known as ‘Tofu Projects,’ or ‘Tofu Dregs’ where substandard and often dangerously poor materials and practices are used to save money.
Evergrande’s teetering caused panic amidst the entire real estate market as other companies faced capital shortages, panic and runs on the banks. In May 2022 several local banks completely froze all assets, and depositors were unable to access their funds. The ensuing panic and protests, uncommon in the authoritarian state, then led to crackdowns both on those protesting, and potentially on other banks’ ability to allow withdrawing cash. While not necessarily proven to be directly connected to anything due to the opaque nature of Chinese financial and institutional data, it is probable that the current bank crisis is directly related to the real estate crisis.
As noted above, the real estate market makes up a significant portion of the Chinese economy. Given the limited avenues for investment available to the common people, many choose to either invest in real estate or in financial products offered by the banks, who in turn often invest in real estate projects to some extent. In addition, with real estate traditionally seen as a safe investment, so-called ‘shadow banks’ will often invest the money of depositors themselves to get returns. As such, not only is a significant portion of the economy made up of real estate, but a significant portion of savings are also tied up in real estate and real estate projects.
When Evergrande and other real estate developers stopped working on real estate projects due to either the pandemic or running out of funds, many buyers were forced to stop repaying their mortgages. Since nearly every Chinese bank is involved in selling mortgages, this represents a massive hit to their cash flows. This could explain why some are unable to withdraw money from their accounts - there may simply not be enough. In addition, the issue has been exacerbated by the flight of High Net-Worth Individuals (HNWI), and their assets, from the country following both economic downturns and crackdowns by the government on all sectors of society. This outflow of HNWIs, and their capital, caused the government to place heavy restrictions on withdrawing money from all banks; even those not affected by the real estate crash.
As Country Garden, now the largest real estate developer in China, also faces potential defaults, the probability of a near-total collapse in the real estate sector continues to grow. While the situation is unlikely to spiral completely out of control, the domestic and international shocks will almost certainly set back China’s plans on the global stage. From potentially restricted abilities to lend for the Belt and Road Initiative due to this loss of capital, to the setbacks in plans of using the RMB as an international reserve currency due to this loss of faith, China now faces an uphill battle to even return to where it was just two years ago. That is just the domestic ramifications as well, but on the global scale the instability of the Chinese market may drive businesses out of China, worsening the already existing shrinkage of foreign industries in China, as well as weakening their political position on the global stage, which has largely been built on their economic successes up until now. Either way, the upwards trajectory of the Chinese state that seemed certain now hangs in the balance.
Comments