Will the Current Property Market Downturn in China Lead to a Financial Crisis?

As of August there is no end in sight to China’s property downturn. The crunch is likely to continue given that Chinese authorities are not relenting in their drive to deleverage the sector. Even with the ongoing relaxation of property purchase restrictions and reduced mortgage rates, we expect that real estate investment and other core real estate indicators will remain weak. 

While the risks of a financial crisis are real, the likelihood of such a scenario is low. China has the necessary tools to manage and avoid a financial crisis—and is using them. The country is maintaining liquidity levels in the market and intervening as necessary to prevent systemic risks, including those posed by overleveraged developers. Also, in China, mortgages are basically full recourse loans, as borrowers are personally liable beyond the collateral (i.e., the property asset); and the down payment ratio is relatively high. 

But the economic pain is likely to increase. Estimates suggest the property sector contributes up to 25 percent of China’s GDP growth due to its importance as a driver of demand for commodities and industrial activity (e.g., building materials, household goods, etc.). It is therefore not surprising that the ongoing property downturn is one of the key drivers behind China’s current growth slowdown. Looking forward, we expect demand for new houses to remain restrained, leading to continued weakness in housing prices and in property investment, which in turn will affect upstream industrial activity and important consumer spending categories. This could lead to a situation where the decrease of property value relative to households’ liabilities (not only mortgages) could weaken balance sheets to such an extent that it reduces their incentives to borrow and spend in general. This could give rise to a vicious cycle: the slowdown in economic activity negatively affects job creation and income growth, which in turn weakens consumer confidence and reduces households’ willingness to spend. 

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