The Chinese real estate sector: A cause of the next global economic crisis?
Reflecting on Evergrande
It has been quite a while since the Chinese real estate developer Evergrande has caught the media's eye. Last year there was great ambiguity regarding the company’s possible default on their enormous debt of over than US$300 billion. With several bond payments overdue, and many suppliers protesting in front of the headquarters because of outstanding payments, the collapse seemed imminent. Internationally, many economic experts were warning of a possible global economic crisis if the company filed for bankruptcy. Evergrande, the second largest real estate developer in China, employed more than 120.000 people in 2020, but was indirectly responsible for an estimated 3.8 million jobs. Therefore, if Evergrande collapsed, the consequences would have not only been devastating for the Chinese economy, but would have also affected countries around the world that were depending on the high growth rates and rising demand from the world's most populous country. Despite this, since Evergrande resumed their bond payments on November 10th 2021, media reports about the company have been fading away.
Looking Forward
Nevertheless the problem may well be much larger than many realise, and there still could be an economic recession coming. The roots of this precarious economic reality started with the implementation of the so-called “Three Red Lines Policy” in 2019, which aimed to regulate of the booming, and likely overheating, Chinese real estate sector. Those three lines were:
Liability to asset ratio of less than 70%
Net gearing ratio of less than 100%
Cash to short-term debt ratio of at least 1
Depending on the number of criteria a company fulfilled, the debt level that the company was allowed to hold increased. This showed that the Chinese government was already worried about the real estate sector, and with good reason. With growth rates in the double-digit range, the question remains: how many new homes does China need, and when will the boom slow down?
Many of the new middle and upper class citizens have been investing in property, building themselves a second or even third home, many of which are not occupied. This has led to numerous headlines about ‘ghost towns’ in the middle of nowhere, and pictures of half finished buildings standing lonely in communist-style planned cities. This investment phenomena has created a spiral of developers and suppliers working ever faster to build increasingly more houses for which they have also borrowed great sums of money. If any part of this cycle comes to a halt, the whole system could collapse and send China, and the World economy, into the next recession. Finally, one glaringly important question that still stands unanswered is whether the Chinese government will be willing to rescue collapsing firms, and if so, how far would their efforts extend?