Home Financial responsibility DBRS Morningstar: China’s Balancing Act: containing the leverage effect of the real estate sector while preserving financial stability

DBRS Morningstar: China’s Balancing Act: containing the leverage effect of the real estate sector while preserving financial stability

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NEW YORK–(COMMERCIAL THREAD) – Slowing property sales and tighter financing requirements have brought Evergrande Group, China’s largest real estate developer, to the brink of default. Several other developers also missed the payment of the bonds. In a new commentary, we examine recent dynamics in the Chinese real estate market, the potential macroeconomic implications of an industry downturn, and the delicate balance the authorities face between a firm stance to contain debt in the real estate sector while preserving stability.

The Chinese real estate sector has been a key driver of growth for two decades. Construction and real estate services increased from 9.6% of GDP in 2000 to 14.4% in 2020. This has resulted in an increase in the debt levels of real estate developers, and more recently of households. In an effort to contain leverage and speculation in the real estate sector, regulators introduced strict guidelines for developers and banks in August 2020, which resulted in slower sales. This exposed heavily leveraged real estate developers like Evergrande, who relied in part on early home sales to fund construction activity. Deleveraging the real estate sector will test China’s will and ability to avoid a broader credit crunch and collapse in house prices. We expect that China’s major banks will have adequate capacity and support to absorb credit losses, and the authorities should step in to facilitate an orderly restructuring of the sector. It is less clear how the government will react to falling house prices or declining real estate activity, and the implications this could have for the Chinese economy and politics.

Highlights:

  • A two-decade debt-fueled expansion in China has generated economic imbalances and financial fragilities in some sectors, including real estate. The continued efforts of Chinese policymakers to steer the economy towards a more balanced growth mix and ensure financial stability will likely lead to slower but more sustainable growth in the future, which we would view positively from a credit perspective.

  • The Evergrande crisis embodies the delicate balance for the authorities between containing the leverage effect in the economy while preserving financial stability. Tightening regulations are the main reason for tensions in the real estate sector. Given President Xi’s emphasis on “common prosperity,” the authorities are likely to step in with orderly restructuring to avoid a total credit crunch.

  • However, orchestrating a move towards a more balanced growth mix involves significant downside risks in the short term. The fallout from developments around Evergrande could have unintended effects that spill over into the financial system and the economy, potentially resulting in significantly lower growth prospects over the next few years.

“The Evergrande crisis embodies the delicate balance for the authorities between containing the leverage effect in the economy while preserving financial stability. The fallout could have unintended effects that would spill over into the financial system and the economy, potentially leading to significantly lower growth prospects over the next few years, ”notes Rohini Malkani, senior vice president of Global Sovereign Ratings. “Given President Xi’s emphasis on ‘common prosperity’, the authorities are likely to step in with orderly restructuring to avoid a total credit crunch.”

To read the full report, click here: https://www.dbrsmorningstar.com/research/386308/chinas-balancing-act-cipient-property-sector-leverage-while-preserving-financial-stability

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