China’s largest developer, Country Garden, just announced that it will default on $187 billion of its debt. There is no guarantee that the company will be able to get out of this debt crunch either: “Prevailing market conditions have made it difficult for the group to procure sufficient cash to enhance its liquidity position within a short period of time,” the company said in the statement. “Consequently, the group’s cash position remains under significant pressure.” The reason cited by the company was the drop in presales of unbuilt apartments, which was down 81 percent from a year earlier. But the real reason for this drop is much bigger than Country Garden and even bigger than the country’s enormous real estate industry.
China has a “closed” capital account policy. That means that money can not be moved outside of its financial system without express reasons to do so. This move is meant to prevent capital flight that comes from heavy taxation or, in this case, authoritarian control of wages. Doing so forces Chinese citizens to keep the vast amounts of wealth they have created in the last five decades in Chinese investments. For a long time, the preferred investment vehicle for Chinese citizens was property, and since financing options for property companies were scarce, they would often presell unbuilt units as a prime investment opportunity.
But after another Chinese developer, Evergrande unexpectedly ran into financial issues, the confidence that Chinese citizens have in the property sector has been shaken. This has resulted in a spiraling drop in property sales, particularly presales, making it even harder for Chinese property companies to pay their debt obligations. Making matters worse, the Chinese are one of the only countries in the world experiencing deflation, so they are finding it harder to pay off foreign creditors.
The communist party in charge has already made statements that they will try to “adjust and optimize” property policy to help their economy but added few details except for the fact that it would be done with city-specific measures. If the property market gets bad enough, it might have no choice. Real estate accounts for around 30 percent of China’s GDP and is estimated to be up to 80 percent of its citizen’s household net worth. Cities will also be keen to save local developers; they have been the main source of revenue for many Chinese localities for years. The Chinese people tend to be very frugal, and they save around 45 percent of their income compared to 17 percent in the US. But the government has not been as conservative. Believe it or not, the overall debt within China, including households, companies, and the government, had reached 282 percent of the country’s annual economic output, higher than the 257 percent in the United States.
This will not be the last time we hear about the Chinese property market. There are deep economic issues that China needs to address. The powerful, centralized government that the country has gives them a lot of strings to pull when it comes to improving their economy. But one thing that might be harder is figuring out how to get the confidence of the Chinese people back. They have seen how the lack of transparency about debt in the property industry can threaten their savings, and they will need a lot of convincing, if not a complete overhaul of the financial industry, to win back their trust.