Property downturn: what are the effects? – Sara Hsu

Whether China property bubble is popping, or more slowly evaporating, the effects on its economy will be enormous. Financial analyst Sara Hsu lists three of the most important effects for The Diplomat. She predicts no crash, but very serious effects indeed.

Sara Hsu:

First, and most directly, demand for manufactured construction materials like steel beams, as well as construction services will continue to decline. The construction industry alone employed more than 13 percent of the urban work force in 2012 according to the National Bureau of Statistics. This will have knock-on effects through the economy as workers lose wages and are unable to maintain current levels of consumption. This means that as consumption by laid off workers declines, industries that usually receive the benefits of their spending (such as grocery shops and retail outlets) will suffer through the multiplier effect and will be forced in turn to contract their spending too.

Second, real estate asset price declines will have an impact on household savings. As Nicholas Borst of the Peterson Institute points out, household wealth will decline as real estate values fall, as real property is viewed as an investment, leading to a decline in consumption given the negative shock to households’ holdings. This will further exacerbate the downturn in consumption caused by declining wages, with a net effect of reducing household standards of living and potentially generating social discontent. What is more, the drop-off in consumption comes at a time when the leadership is attempting to ramp up consumption in order to move away from the current investment-led model of growth.

Third, as real estate developers continue to find themselves unable to sell their properties, they will default on loans from various sources. Property developers borrowed heavily from banks until regulatory authorities warned banks in 2012 that there may be losses in the real estate sector, after which bank loans to property developers and local government financing vehicles were restricted. Property developers turned to trust companies and other shadow banking entities to obtain funding. Recently regulators have warned shadow banking entities such as trust companies to restrict lending to the real estate sector, but at this time the move appears to be too late to prevent financial fallout. In the short run, liquidity issues will likely present a real problem to the shadow banking sector and to some components of the banking sector. If liquidity issues become severe, solvency of shadow banking entities like trust companies and third party entrusted lenders may pose a problem. Middle class households that purchased wealth management products through banks and securities companies containing shadow banking loans will likely be outraged if payments are defaulted on, if recent history is any guide. This may provide yet another source of social unrest.