�۶���Ƶ

Property developers have become systemically important: the sector now accounts for an estimated one-third of China’s economy. They are also increasingly highly leveraged as well as more concentrated. Back in 2013, the top 50 developers accounted for approximately a quarter of property development (Chart 1). Fast-forward to 2019 and they account for 60% of new building activity. In our view, when 2021 numbers are published, the top 50 developers are likely to account for around 70% of new building activity, making it especially important that the government acts to ensure they are financially viable. The ‘three red lines’ policy is designed to reign in the property development companies, slowing the speed of over-leveraging and preventing firms from taking on more obligations than they are capable of repaying (which may lead to their collapse and failure to deliver properties).

In China, as opposed to some other countries in the Western hemisphere, people typically pay for their properties up front before they are built. Given that property is expensive relative to average incomes, it is important to the government that the sector is sensibly levered. Thus, while there’s now a big slowdown in property developers’ activity, this is because of government policy and not because of a lack of demand. Fundamentally, demand is still outstripping supply, and this will likely be the case for many years.

To balance the strong demand for housing whilst creating a healthier property development sector, implementing the ‘three red lines’ policy¹ is the government’s way of managing a property development corporation at the balance sheet level. Shunning de-leveraging is no longer an option for property companies, as they will eventually come under those regulations. However, developers that are currently failing some of the rules still have time to meet the requirements. While the ‘three red lines’ provides a framework that developers must now operate under, they have until 2023 to fully comply.

¹ Thresholds on three financial ratios: a liability-to asset-ratio of less than 70%; A net gearing ratio of less than 100%; a cash to short-term debt ratio of more than 1x

One of the most telling ways to look at China’s economy is to look at its credit impulse indicator (Chart 2). This shows the change in new credit issued as a percentage of GDP and typically marks turning points in economic activity. The chart clearly shows that historically, the Chinese credit impulse has cycles, and that post-peak troughs follow a pattern. The impact of China’s policy tightening has resulted in a notably sharp decline in the credit impulse. This is because in previous cycles, the tightening of credit availability was aimed at individual sectors. However, numerous industries have been targeted across the economy during the last regulatory crackdown: credit has been taken away from the economy as a whole very quickly. Therefore, we believe that it follows that the decline in the credit impulse is more acute than in the past.
Today, the credit impulse line is almost in line with the trough of previous cycles. The question is when will the credit impulse indicator head back towards positive territory and what factors would help it to do so? We would argue that it is possible that China’s credit tightening has almost run its course and could now start to show signs of reversing in the early part of 2022, albeit at a modest pace.

Given the importance of the property sector to the economy – as mentioned earlier, property is about 30% of the economy, while infrastructure spending is about 15% – if property developers aren’t feeding into that spending on infrastructure, then it’s to be expected that the economy is slowing down, as reflected in the credit impulse signal. There are early indications of some easing in the credit sector which could be the first steps in a broader policy adjustment. According to news reports¹ Chinese regulators have eased residential mortgage quotas for the rest of the year for banks. In addition some banks have been told to accelerate the approval of mortgages. These measures should ease liquidity stress in the sector, as mortgage funding drawn by end-buyers is channeled to the property companies in the form of payments. China’s central bank also broke its silence on the Evergrande crisis in mid October, expressing confidence by saying risks to the financial system stemming from the developer’s struggles are “controllable” and unlikely to spread. In our view, this indicates that the central bank is keeping a close eye on the situation and will seek to manage the fallout.

¹ Bloomberg, 15^th October 2021