Real estate risk emerges in China with the liquidation of Evergrande

The real estate sector has been under the microscope of regulators, government, analysts, and investors for just over two years, after the Chinese giant Evergrande defaulted on its offshore debt in 2021, which at the time amounted to 300 billion dollars (about 304 billion euros). Now, after years of litigation, the High Court of Hong Kong has this week ordered the company to liquidate, having shown itself unable to present a proposal to restructure its liabilities, which amount to 328 billion dollars (about 320 billion euros).

The troubled situation of the country’s leading real estate developer comes in addition to an overall decline of real estate investment. Data from November show a contraction of 9.4% in total real estate investment. Specifically, the decrease is 9% in residential, 10% in offices, and 17% in retail space. New construction starts were down by more than 20% and developer finance was off by 13.4%. Thus, the climate index in the real estate sector has been falling for three years in a row, and it now stands at 93.4 points.

MAPFRE Economics, MAPFRE's research arm, has identified financial and real estate stress in China as one of the main risks facing the global economy. This is especially so if one recalls that the percentage of China’s GDP represented by the real estate sector as a whole is similar to that of Spain when the latter country’s own real estate crisis broke out.

Nevertheless, the order to liquidate Evergrande, if made official, may even prove to be positive for the real estate sector: the problem is being acknowledged and the solution is being implemented.

Moreover, this real estate crisis is of a local nature, whereas other crises, such as the one in the United States in 2008 that triggered the financial crisis, were much more international: real estate debt was being securitized and then sold to investors all over the world.

“It’s a big and probable risk with a considerable real cost, but its central role isn’t as great as our intuition would seem to indicate, given that the Chinese economy is relatively isolated from the world, financially speaking,” explains MAPFRE Economics in its report “2024 Economic and Industry Outlook.”

The Chinese government has taken a number of measures to aid financially stressed regional governments, and it’s aiming to tackle challenges in the real estate market, such as the problems faced by large developers. For instance, the central bank's monetary policy adjustments aim to sustain the credit flow, while it has announced unexpected fiscal support of 1 trillion yuan, thus increasing the deficit to 3.8% of GDP.

Currently, the country's growth is being sustained by sectors such as automobile production, where it has surpassed Germany and Japan, although it’s expected to gradually slow down as the country converges towards developed economies.

In its baseline scenario, MAPFRE Economic Research forecasts a 4.4% increase in GDP this year and 4% next year, while in the stressed scenario, GDP would be down to 3.5% in 2024 and 3.7% in 2025.

Despite these figures, which are worse than in previous years, China is showing marginal advances compared to the previous edition of the Outlook report, with a growth range at a new potential level that may fall below 5% and a risk of deflation that that isn’t receding, given that government support remains cautious. This combination, together with the unresolved real estate crisis and its smaller presence in supply chains, is resulting in a lower overall contribution to growth, but also weaker, hard-to-replace deflationary momentum.

Another important factor highlighted by MAPFRE Economics is that there needs to be as much cooperation as possible between the authorities in Hong Kong, where the liquidation was decided and where the company is listed, and China, where most of its assets are located. Both territories have been in a tense standoff for several years now, ever since Hongkongers took to the streets en masse in 2019 to protest against the restrictions on civil liberties, among other things.

Tensions with Taiwan are also on the risk agenda for this year, especially since the January 13 elections, where Lai Ching-te, leader of the Democratic Progressive Party (DPP) and a defender of the island’s independence against China's sovereignty claims, emerged victorious.

“This is a central issue in the U.S.-China dispute. The recent victory of the incumbent party is likely to maintain the status quo with respect to China, in contrast to the opposition, which is more inclined toward negotiation. But an overt conflict can be ruled out for the time being, as it is not in either party’s interest,” explains MAPFRE Economics.