China’s real estate crisis: why it’s so hard for Beijing to solve

The Chinese stock market was falling and its currency was swinging. The head of the central bank, answering questions at a rare news conference, said China would make it easier to obtain mortgages.

It was February 2016, and Zhou Xiaochuan, the longtime central bank governor at the time, announced what proved to be the beginning of an extraordinary campaign of lending by China’s massive banking system.

Minimum down payments for the purchase of apartments have been lowered, which has led to an increase in construction. Huge sums were also lent to local governments, allowing them to boast new roads and railways. For China, that was a familiar reaction to economic woes. Within months, growth began to pick up and financial markets stabilized.

Today, as China faces another period of deep economic uncertainty, policymakers are drawing on elements from the playbook, but with few signs of the same results. It has become very difficult for China to borrow and invest its way back to economic power.

On Friday, China’s top financial regulators summoned the leaders of the country’s leading banks and securities firms and urged them to provide more loans and other financial support to the economy – the latest in a series of similar warnings.

But the demand for more borrowing has waned in recent months, eroding the effectiveness of more flexible lending policies by banks.

The construction and sale of new homes has stopped. More than 50 real estate developers have run out of money and defaulted or stopped paying bonds. The companies left behind hundreds of thousands of unfinished apartments that many predominantly middle-class families had already purchased, and took out mortgages to do so.

At the same time, companies are wary of borrowing money in order to expand as their sales plummet and the economy faces a downturn. Local governments across much of China are heavily indebted and struggling even to pay their civil servants. Years of massive investments in infrastructure, followed by huge amounts of spending on mass testing and quarantines during the pandemic, has made China less willing to employ financial firepower to shock demand.

“The traditional method of stimulating the economy, through credit boom and leverage, has come to an end,” said Zhu Ning, deputy dean of the Shanghai Institute of Advanced Finance.

Western economists have long maintained that the answer to China’s economic problems lies in reducing the country’s high rate of savings and investment and encouraging more consumer spending. The World Bank adopted this stance in 2005, after China ran into banking problems in 2003 and 2004 from an earlier round of heavy lending.

But China has done little to strengthen its social safety net since then, so that families don’t feel the need to save so much money. Government payments to the elderly are minimal. Education is increasingly expensive. Health care insurance is mostly the responsibility of the municipal government in China, and the high costs of the strict “Covid zero” measures employed by the country have bankrupted many local government plans.

During the pandemic, some states have issued coupons for free or discounted restaurant meals and other services to spur spending. But while some Chinese city governments have experimented with such steps, the scale has been small — offering individuals handfuls of coupons worth a few dollars a piece.

The idea of ​​using this kind of direct spending on a national scale is contested at the highest levels of the Chinese government. China relied heavily on food ration vouchers beginning under Mao and continuing into the early 1990s but today lacks the reliable administrative systems that would be necessary.

China’s leader, Xi Jinping, has a known aversion to any social spending, which he has derided as a “welfare,” and which he believes could undermine the work ethic of the Chinese people.

“Even in the future, when we reach a higher level of development and are equipped with more large financial resources, we should still not aim too high or exaggerate social security, and stay away from the welfare snare that breeds idleness,” Xi said in a speech. I met him two years ago.

At the heart of China’s current economic woes is real estate, which accounts for a quarter of the country’s economic output and at least three-fifths of household savings.

When Mr. Zhou, the former central bank chief, unleashed a wave of borrowing in 2016, it sparked a wave of apartment building even in remote cities like Qiqihar, a vanishing, frozen center of artillery manufacturing near the Siberian border. As easy credit drove up apartment prices, people in Qiqihar and across the country felt richer and flocked to car dealerships and other businesses to spend more money.

The apartments were bought as rental investments, including by many Chinese families who saw an opportunity to accumulate wealth. But as more and more apartments were built, their value fell as rents fell. Investors are left with apartments whose rent does not pay off their mortgages. In many cities, annual rent was 1.5 percent or less of the purchase price of an apartment, while mortgage interest costs were 5 or 6 percent.

Apartments in China are usually delivered by builders without amenities like sinks and washing machines, or even basics like closets or floors. With rents so low, many investors haven’t bothered to finish apartments over the past decade, carrying around newly built but hollow shells and expecting to flip them for ever higher prices. By some estimates, Chinese cities now have between 65 and 80 million empty apartments.

Demand for new apartments is now down, leaving little expectation that a repeat of Mr. Zhou’s actions in 2016 will quickly revive the market. The annual number of births and marriages has almost halved since 2016, eroding much of people’s need to buy new apartments.

Existing home prices have fallen 14 percent in the past 24 months. New home prices haven’t fallen as much, but only because local governments have told developers not to cut prices so drastically. As a result, new home sales plummeted.

Many economists in China are now pointing out that the country needs to get past cuts in down payments and also cut interest rates sharply, way beyond Monday’s minuscule rate cut. Deep cuts in interest rates will make it much cheaper to borrow money for a new home, car, or other large purchase. It could also stimulate more exports, a longtime driver of the Chinese economy.

The dangers of lower interest rates are that Chinese businesses and households will be able to earn much higher interest rates on bank deposits in other countries, and will try to transfer large sums of money out of China. This will cause China’s currency, the renminbi, to fall against the dollar, which will make Chinese exports more competitive in overseas markets.

China cannot export its way out of economic troubles without incurring significant hostility from governments in Europe, the United States, and developing countries, which are becoming increasingly reluctant to accept the job losses associated with dependence on imports. But this could be a risk that China is willing to take as pressure for further rate cuts increases.

“Cutting interest rates is essential,” said Xu Setao, chief economist at Deloitte’s Beijing office. “It’s about stabilizing the real estate sector and providing calibrated relief to companies and local governments that are struggling with funding problems.”

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