Chinese property sector debt crisis deepens

Country Garden, China’s largest property developer, has received a liquidation petition after it failed to repay a loan worth $205m to a Hong Kong creditor.

In what is the latest bad news to come out of China’s crippled property sector, the announcement led to the company’s shares falling by more than 12 per cent in early trading on Wednesday.

In October last year, Country Garden defaulted on a $15.4 million interest payment. The property industry accounts for between a quarter and a third of China’s GDP and has powered the country’s economic boom over the past twenty years. 

This boom has in crucial ways always been a bubble. In the 1990s, property was privatised and the Chinese population moved from rural areas to cities in their millions. Property developers would announce construction on a site and use the pre-sale money to invest in new land rather than in completing the project. This meant that when demand plummeted and the pre-sale money stopped flowing in such vast quantities as before, there was no money to finish construction. Those who bought while property prices were high have been hurt by the falling prices. It is estimated that 65 million properties lie empty.

Employment in the construction sector peaked in 2020 when it recorded over 62 million jobs. In the same year, direct investment in real estate reached about RMB 7.5 trillion (US$1.18 trillion), a contribution of around 7.4 per cent to GDP.

The bubble burst in 2021 with Xi Jinping’s crackdown on property being used as a way to make money rather than solely as a place to live. Xi introduced a tightening of the regulations on the property sector. What has been called the three red lines policy demands that: property developers must keep their debt at less than 70 percent of their assets; maintain a debt‐to‐equity ratio of less than 100 percent; and a ratio of cash to short‐term debt of at least 100 percent. 

This has led to property companies defaulting on their debt as it has become increasingly difficult to borrow large sums. Evergrande, China’s second largest property developer is also in huge financial trouble. Its chairman Hu Ka‐yan has been detained for potential financial crimes. Both companies are now in the process of restructuring their debt payments, with Country Garden using KPMG to sort through the mess. 

With reference to the recent liquidation petition, Country Garden said: “The radical actions of a single creditor will not have a significant impact on our company’s guaranteed delivery of buildings, normal operations and the overall restructuring of overseas debts.”

As Iain Martin wrote in his newsletter back in August, China’s property crisis is not new. Michael Auslin’s 2017 book The End of the Asian Century predicted just as much, and that was even before the Chinese government changed its policy from backing the ludicrous amounts of debt to letting the companies go under. 

The Cato Institute argues it is most likely that Shanghai will bail the banks out while Lingling Wei of the WSJ thinks that the detention of Evergrande’s chairman shows that Xi will look for scapegoats to blame the mess on. In the end, Xi may do both. 

The crux of the matter is that the domino effect of a total collapse in the property sector of the world’s second largest economy would be catastrophic. Financially, the world would feel it, and geopolitically, a bankrupt China could be more volatile than ever.