Breakingviews: Real estate will defeat Beijing, again

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HONG KONG (July 21): You lose some, you lose some. President Xi Jinping’s war on property speculators, which began in 2020, was a good idea at a bad time. As with previous attempts, the government has bitten off more than the economy can currently chew. Now buyers are in open revolt and the market is collapsing, jeopardizing recovery – and stability – more. Capitulation by the Chinese government seems inevitable.

Real estate contributes up to a third of economic output; state media estimates that 70% of citizens’ financial assets are parked in homes. It’s not surprising. For decades, Chinese real estate has been a risk-free bet on appreciation, where returns were limited only by borrowing capacity. With house prices in some cities equivalent to more than a decade of annual wages, however, economists worry that mortgage payments are being deducted from consumption and discouraging family formation.

An attempt to cool the market in 2014 and 2015 did so much collateral damage that officials quickly changed their minds. This reinforced suspicions that the developers had accumulated so much systemic risk that they had become invulnerable to discipline, and speculation resumed. Xi, a disciplinarian, therefore tried again, implementing a “three red lines” policy in 2020 that shut leveraged firms like China Evergrande out of credit markets.

Unable to refinance and facing slowing sales, weak developers defaulted on contractors, who stopped building. This has prompted irate buyers in several cities to threaten to suspend mortgage payments for unbuilt properties, a move that is difficult to suppress. Analysts estimate that between 500 and 600 million square meters could be suspended, which is equivalent to 10 Manhattans. With nearly a fifth of working-age young people out of work, Beijing is accelerating new infrastructure spending to create quick jobs, but the benefits will be undone if no one picks up the construction of these incomplete apartments.

Average construction costs per square meter are around 4,000 yuan according to official estimates, implying that at least 2 trillion yuan ($300 billion) is needed to deliver unbuilt projects to their owners, who will then start making payments to their nervous bankers again. Given that the problem has been publicly metastasizing for a year now, some might wonder why officials haven’t waved their financial wands already.

There is no magic wand. First, any bailout bails out the entities and people Beijing has tried to squeeze, namely irresponsible developers and speculators who bought non-existent apartments on credit. This will reinforce the moral hazard that Xi is trying to eradicate. Second, the institutions best placed to take over projects and finance their completion – local governments, public developers, banks and government asset managers – are themselves under financial pressure due to broader economic malaise. . That’s why they were slow to intervene. The central bank, which continues to grapple with the country’s vast pile of bad debt and has to worry about capital flight as the dollar soars, has refrained from cutting interest rates sharply to stimulate monetary growth.

Finally, it is difficult to catch a falling knife. Funding existing projects will end current boycotts but not necessarily revive demand in a declining market that hosts enough empty apartments for 90 million people, according to Rhodium Group estimates. As developers’ cash flow problems worsen, they could put even more projects on hold, requiring even more interventions.

Indeed, the central government has already eased some lending restrictions to the sector. Local elected officials, who rely on land sales to cover their budgets, are trying to rekindle the interest of buyers, without much success. Slowly but inexorably, Xi is pushed back beyond his three red lines. The longer it takes him to admit temporary defeat, the longer he may have to surrender.

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