At a time when the Chinese economy is facing multiple challenges, including an energy shortage and supply chain problems that have disrupted multiple industries, an expanding crisis in the real estate sector threatens even further damage.
For months, the slow-moving default crisis at China Evergrande Group, one of the country’s largest property developers, has put a spotlight on the real estate sector, which makes up a much larger share of gross domestic product in China – nearly 30% – than it does in most developed countries.
The crisis has accelerated in recent days, with more real estate companies defaulting on their bond payments, or asking for forbearance from creditors in order to avoid default.
Experts warn that the deterioration of the Chinese real estate sector could lead to reluctance of foreign investors to place bets on Chinese companies in general – bad news at a time when the government in Beijing is struggling to manage multiple problems.
The crisis in the property sector comes at a particularly bad time for China, which is currently facing widespread shortages of coal, which it uses to generate around 70% of its electricity.
The coal shortage is driven by a number of factors, including a boycott by China of Australian coal put in place last year after officials in Canberra demanded an investigation into the origins of the COVID-19 pandemic, which first appeared in China.
But China has also placed a series of new regulations on coal mines while simultaneously requiring that energy prices be kept artificially low. This led to disinvestment in the coal sector, and lower production.
This week, Beijing announced that it will allow energy firms to set prices on the open market without a ceiling, which will make electricity significantly more expensive, but will also incentivize more production.
The moves to improve the supply of energy are not expected to achieve real results until sometime next year. Meanwhile, the energy shortage has cascaded through the Chinese economy. The country has faced intermittent blackouts that have impacted everything from heavy industries like steel, aluminum and cement, to the manufacture of electronics and other consumer goods.
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Broader problems in real estate
At a time when foreign investment could help drive improvement in the country’s energy sector, the struggles of the property development market are making those investments look more and more risky.
Evergrande’s failure to make payments on a pair of dollar-denominated bonds last month – and the Chinese government’s apparent lack of interest in bailing out the company – has raised questions about the future of the conglomerate, which has more than $300 billion in debt still outstanding.
On Tuesday, investors in Evergrande bonds reported that the company had missed another payment of $148 million.
Now, the crisis at Evergrande seems to be infecting other firms in the property sector. Last week, Fantasia Holdings Group, a Shenzhen-based property developer, shocked the markets by defaulting on a $206 million payment. Days before, the bonds had been trading at 99 cents on the dollar, suggesting that investors thought it highly likely that the company could service its debt.
On Tuesday, another firm, Sinic Holdings, announced that it does not expect to be able to make a payment on a $250 million bond coming due next week, and that the failure will cause it to “cross-default” on two other outstanding bonds.
Still more firms are showing signs of imminent distress. Modern Land Co., based in Beijing, has asked creditors for a three-month extension on a pending payment, and Xinyuan Real Estate has asked its creditors to trade bonds coming due on Friday for new bonds that won’t mature until 2023, a move rating agencies see as tantamount to default.
The series of defaults in the property sector has given international investors reason to be extremely leery of the Chinese property market. Moody’s Investors Service, Fitch Ratings and S&P Global Ratings have all slashed credit ratings on a host of Chinese developers.
Bondholders who were willing to accept a 10% interest rate on Chinese junk bonds – securities considered to be below “investment grade” by ratings firms – are now demanding rates above 20%, in some cases. Holders of existing bonds are expecting to take significant “haircuts” on their holdings, meaning that they will be forced to accept less than they are owed.
A drag on economic growth
High borrowing costs are likely to be a persistent problem for Chinese companies, Doug Barry, a spokesman for the U.S.-China Business Council, told VOA.
“A problem for the Chinese economy is that it will cost higher rates of return to sell Chinese debt in world equity markets,” he said.
Barry said that the likely result is that China will receive less investment capital from overseas in the future, which will hamper economic growth.
“The immediate effects could be lower levels of investment and lower levels of growth,” he said. “This, paired with energy shortages, represents a one-two punch. Foreign companies with substantial investments in China are watching closely with an eye toward keeping supply chains intact and costs stable.”
“The world economy is intertwined with China’s, ‘like lips and teeth,’ to use a Chinese expression,” he added. The hope is that officials will get a grip on the immediate problems and do the work necessary to stabilize for the longer term financial, property and energy markets.”
Public concern limited
Tianlei Huang, a research fellow at the Peterson Institute for International Economics, said in an email exchange with VOA that inside China, there doesn’t appear to be broad public concern about the crisis in the real estate sector seeping into other parts of the economy.
However, he added, “There is no denying that Evergrande’s debt is worrying. Though the overall debt held by financial institutions is limited, certain banks with high exposure to Evergrande and other weak property developers could suffer a heavy blow and see a sharp deterioration in asset quality should there be a cross default.”
The lack of widespread public concern may be due, in part, to how difficult it is to get a full picture of the indebtedness of large Chinese companies.
“What is equally worrying is that Evergrande also has lots of off-balance-sheet debt and it is unclear how much,” Huang said.
Many Chinese firms supplement bank loans and bond issuances with other sources of funding, including investment capital routed through wealth management firms seeking high returns for their clients.
“You may have seen videos of gatherings of investors in front of Evergrande’s office buildings asking for repayments,” he said. “Local governments are now on high alert for any large-scale gatherings related to Evergrande.”