'Real estate crisis will severely affect China's flesh for several years'

ANALYSIS || "For China, the only way out of this crisis [in the real estate sector] is a slow but painful adjustment. "

Hong Kong

China's strong growth, one of the fastest sustained expansions of a major economy in history, has been fueled for decades by a boom in real estate fueled by population growth and urbanization. But the important real estate market, which used to account for 30% of the economy, has been in crisis for more than two years after the government imposed credit restrictions on developers. Investment in the real estate sector fell last year for the first time in a decade, and without some help from Beijing, a recession in the real estate sector is likely''to continue, posing a serious threat to China's growth prospects over the next three to five years.

"For China, the only way out of this crisis [in the real estate sector] is a slow but painful adaptation," says Alicia Garcia-Herrero, Natixis' chief economist for Asia Pacific. "The adaptation process has just begun and will take years to complete." The country needs to bring housing supply in line with much lower demand, which is declining due to an aging population, she adds. It's not an easy task.

Last month, a former deputy director of the national statistics office was quoted by state media as saying that China's total population of 1.4 billion''debt, weakness in the real estate sector and an aging population. A few days ago, the International Monetary Fund (IMF) said it expects China's growth to slow to around 3.5% in the medium term from around 5% this year due to demographic factors and slowing productivity growth. The last time China's economy achieved sustained growth at this level was in 1989 and 1990, when growth fell to 4.2 percent and 3.9 percent, respectively, down from 11.3 percent in 1988 due to international sanctions triggered by the Tiananmen Square crackdown. The IMF said future growth could exceed 3.5 percent if Beijing continues its stimulus and economic reform efforts.

How did we get to this point?

For years, many''real estate developers in China had a simple business model: sell apartments before they were completed. Regulators introduced this model in 1994 to meet growing demand as the country moved into a rapid period of urbanization after adopting marketing-oriented reforms. Money from sales funded their rapid expansion, making real estate tycoons some of the richest people in the country. That strategy largely worked until about three years ago, when the Chinese government halted excessive borrowing by real estate developers, fearing financial instability. It also sought to control soaring real estate prices and reduce the risks associated with the debt burden. This decision exacerbated the crisis''liquidity at real estate developers such as Evergrande, which in December 2021 failed to meet its obligations to creditors, triggering a wider crisis in the sector. Evergrande was supposed to be restructured and allowed to revive, but its problems have only worsened. Last week, the company announced that its founder and president Xu Jiaying had been arrested by authorities on suspicion of crimes, alarming investors who had hoped the company would settle its problems with creditors this month. Worries are growing about the future of Evergrande, which has more than $300 billion in debt and hundreds of unfinished apartments across the country. The possible liquidation of the company could affect families and''promoting a "new type of industrialization" in which sectors such as green technology can take the place of real estate.

Real estate plays an important role in the Chinese economy. Real estate accounts for about 70%, the largest share, of household wealth, according to the latest Central Bank 2020 data. Land sales to developers accounted for more than 40% of local government revenue in the years prior to 2021. That figure has fallen to 37% in 2022.

The negative wealth effect

Consumption also does not seem to be an option to fill the void left by the real estate sector. For decades, the boom in the real estate sector has fed the spending of China's growing middle class, which has stored much of its wealth in real estate and felt confident when the value of its''homes were on the rise. Now the "negative wealth effect" from falling house prices is curbing their desire to spend, and people are hoarding money. Families' bank deposits reached a record 132 trillion yuan ($18 trillion) in June, exceeding China's entire GDP last year, according to the People's Bank of China. Families' savings rose 80 percent in 2022 compared with 2021. That's more than a third of their income. Before the pandemic, people saved about a fifth of their income. Capital Economics estimates that the net wealth of Chinese families fell by 4.3% in 2022 due to a fall in house prices and the stock market. It was the first such decline in more than two decades.

"As in Japan in the 1990s, there is a growing loss of confidence among Chinese consumers and investors in the''post-bubble growth model,' Oxford Economics analysts wrote in a report last month. "The obvious place to look for growth is consumption, but achieving it requires significant structural policy changes. "

The challenges to rebalancing

Chinese policymakers face several challenges in making these changes. "Families already have high levels of housing debt and few options for consumption credit," said analysts at Stanford University and the Asia Society Policy Institute (ASPI) in a recent report. "The priority (...) should be for the government to quickly establish alternative sources of pre-