CNA Explains: With another Chinese property giant in crisis, how worried should the world be? 

SINGAPORE: Default risks are once again flashing in China’s real estate sector.

Country Garden, which was the country’s largest property developer by sales volume before this year, is faltering amid record losses, mountains of debt and missed payments to lenders and workers.

This comes two years after similar woes at Chinese property titan China Evergrande, which ignited rare protests in the country by aggrieved home buyers and retail investors.

For decades, the property sector served as one of the key growth engines of the Chinese economy, accounting for around a quarter of economic output. Intensifying tremors within the sector have inevitably renewed fears about potential spillover effects on the rest of the country’s economy and beyond.

Here’s what you need to know:

What went wrong?

Previously fuelled by economic and population growth, China’s property sector has in recent years fallen on harder times, partly as the domestic economy slowed and housing demand cooled. These challenges deepened during the COVID-19 pandemic which hurt employment and increased income uncertainties.

It was also during this time when the Chinese government moved to rein in the massive debt accrued by the industry’s biggest players over the decade-long building boom.

In August 2020, Beijing rolled out a “three red lines” policy, a trio of metrics on debt that developers have to meet if they want to borrow more. These essentially tightened conditions for developers to access credit.

Unable to borrow and struggling to sell apartments, developers that had been operating far outside the “three red lines” were thrust into a severe cash crunch, resulting in unfinished homes and unpaid suppliers and creditors.

One of the largest casualties was Evergrande, which was one of China’s largest developers but has turned into the poster child of its sector’s woes after being declared to be in default in late 2021.

Following a prolonged debt restructuring, Evergrande – the world’s most indebted real estate company with debts of more than US$300 billion – filed for protection from creditors in a US bankruptcy court on Aug 17.

Beyond Evergrande, the sector has seen a series of developer defaults since 2021. Reports have said the number of defaults comes up to companies accounting for 40 per cent of Chinese home sales, with most being private property developers.

This time, it is another property titan Country Garden in the headlines for financial distress.

“This is noteworthy because, in addition to its size, Country Garden was previously viewed as being in relatively good shape compared to most other private developers,” said Julian Evans-Pritchard, head of China economics at Capital Economics.

The private developer was included in a government list of “high quality” developers eligible for funding support from state-owned banks in November last year.

“Country Garden’s problems underscore just how bad financial strains in the property sector have become, as well as the failings of existing policy support measures,” Mr Evans-Pritchard wrote in a report dated Aug 16.

The developer’s liquidity stress came to light after it missed two dollar bond coupon payments on Aug 6. It has 30 days to pay up to avoid a default.

It is also seeking to get creditor support on Aug 31 to add a 40-day grace period for the maturity of a yuan bond due on Sep 2, and extend repayment by three years. 

The company’s first-half results announced on Aug 30 showed a record net loss of 48.9 billion yuan (US$6.72 billion), up substantially from a 6.7 billion yuan net loss in the second half of 2022 and a 612 million yuan net profit in the first half of 2022.

Total liabilities for the January to June period stood at 1.4 trillion yuan.

Country Garden said it was “deeply remorseful” for the record losses and warned of default risks if its financial performance continues to deteriorate.

Analysts noted that the developer is particularly susceptible to weak demand because it focuses on the lower end of the property market.

Shares of Country Garden listed in Hong Kong have plummeted nearly 70 per cent year to date. The counter will be removed from the Hang Seng Index on Sep 4 following the index’s latest quarterly review.

How bad can it get?

Experts said that news of yet another top developer teetering on the brink of a default will be a further blow to market confidence and may exacerbate the downturn in China’s property sector.

“Default risk concerns will severely weigh on home buyers’ confidence that, in turn, affect sales. This cycle will worsen the liquidity situation of distressed Chinese developers,” said Coface’s chief economist for Asia-Pacific Bernard Aw.

While the risk of a default by Country Garden is “rising especially amid weak sales”, Mr Aw reckoned that the contagion impact would be smaller than Evergrande’s partly due to the size of liabilities.

Country Garden’s total liabilities of 1.4 trillion yuan are only 59 per cent as big as those at Evergrande.

The property sector has also “gone through a wrenching adjustment” and its problems are now widely known versus before, noted Mr Evans-Pritchard.

“So, the impact of Country Garden’s woes is unlikely to be as severe as the fallout from Evergrande’s default two years ago,” he said.

That said, there are concerns about whether the sector’s worsening woes will hurt the broader Chinese economy, whose post-pandemic bounce is quickly fizzling out.

“Although the direct fallout from Country Garden is likely to be more modest than Evergrande, it comes at a more inopportune time when the wider economy is much weaker and the balance sheets of corporates and financial institutions are in worse shape,” said Mr Evans-Pritchard.

“As such, a hit to growth that would normally be manageable risks tipping the economy into a vicious cycle between falling output, deleveraging and deflation.”

Mr Chen Jingwei, chief investment strategist of Wrise Wealth Management Singapore, said: “A slowdown in (China's property) sector could impact overall growth and significantly affect the adjacent construction industry.

“Other sectors like finance, manufacturing, and local governments – which often rely on land sales to finance public projects – may also experience repercussions.”

Already, there are signs of troubles emerging elsewhere.

Chinese trust firm Zhongrong International Trust, which has sizable real estate exposure, missed payments on dozens of investment products since the end of July. The firm’s second-biggest shareholder Zhongzhi Enterprise Group has said it is facing a liquidity crisis and will restructure debt.

“That’s something that will weigh further on sentiment and will keep (economic) activity pretty depressed in the near term,” said Mr Evans-Pritchard.

Should the rest of the world, including Singapore, be concerned?

Despite the risks, experts are generally still expecting China to meet its growth target of around 5 per cent for 2023.

More stimulus to support growth could be on the cards, although experts such as Mr Evans-Pritchard reckoned that would unlikely be in the form of a direct bailout of distressed developers with authorities “keen to avoid moral hazard”.

Should stimulus steps be taken, these would come in the form of increased fiscal spending to fund big-ticket infrastructure projects, or additional support for consumers and private firms, experts added.

Already, Guangzhou and Shenzhen, two of China’s biggest cities, have eased mortgage curbs this week.

Overall, the outlook ahead for China may be “pretty weak” but it’s “not necessarily catastrophic for the world”, said Capital Economics’ group chief economist Neil Shearing.

“We are not describing a complete collapse in the Chinese economy. It’s low but still positive growth, so we don’t think that it will derail economies in the Europe or the United States” he said in an Aug 17 online discussion on the risks surrounding China’s economic outlook.

“Unless the outlook for China becomes substantially worse, (it is) primarily a China story at this stage.”

Mr Chen from Wrise Wealth Management Singapore also posited that the impact of a default by Country Garden will be “largely contained within the China market”.

“This is somewhat alleviated by China’s slower-than-expected reopening and reduced global financial exposure to the real estate sector,” he told CNA.

On that note, experts said that spillover effects into the rest of the Asian economies are not too much of a concern just yet.

For Singapore, which has China as one of its top trading partners, any impact from the latter’s housing crisis is “likely to be indirect” if growth in China weakens substantially, said Mr Aw of Coface.

Likewise, the impact on investors in Singapore will also be an indirect one.

“Substantial downturn in China’s property sector could result in a global sell-off, including in Singapore,” said Mr Chen.

For individual stocks, such as Singapore-listed developers with operations in China, these will largely depend on their exposure and resilience, he added.

Singapore’s banking sector, for one, does not have a large exposure to the overall Chinese property sector, said Mr Aw, citing information provided by local authorities two years ago in response to the debt crisis surrounding Evergrande.

A parliamentary reply in 2021 said that the exposure of Singapore’s banking system to the overall Chinese property sector “is not large”, with direct exposures to China's property sector making up less than 1 per cent of non-bank loans.

Areas where investors might want to exercise some caution include Chinese property shares and listed bond funds who have exposure to Chinese property issuers like Country Garden, said Mr Chen.

“We anticipate further repayment difficulties in this industry until substantial support and stimulus measures are unveiled by the government,” he said.

“As such, it is prudent for investors to wait for more definitive policy actions that can reinstate market and consumer confidence before re-engaging with such trades in China’s property sector.”