China’s Economy at Increased Risk from a Property Downturn Says Moody’s

Moody’s Investors Service has concluded that China’s economy is at increased risk in the event of a property downturn, and that Chinese authorities are running out of options for mitigating the effects of a slump through fiscal and monetary policies.

“Previously, the banking sector’s exposure to the property market was relatively modest, thus limiting the potential negative impact from a real estate downturn,” Lillian Li, Moody’s vice president and senior analyst, said. “But the rising share of mortgages in new bank credit, the risk from property pledged as collateral on other loans, and the increasing role of shadow banks as providers of finance to the property sector have all raised the financial system’s vulnerability to a property-related shock.”

Moody’s findings compared current data to information from 2014, when the credit rating agency had found that a property downturn in China would be manageable. The new report pointed out that around 25 to 30 percent of China’s GDP is connected to demand from the property and construction sectors, increasing the potential for knock-on macroeconomic effects from a downturn in the property market.

Debt and Fleeing Capital Reduce Authorities’ Ability to Mitigate Downturn

In the event of a real estate slide, China’s general government leverage, which measures public sector debt and was once relatively low, now stands at 36.7 percent, which indicates that the central authorities have a reduced ability to soften the blow of a property downturn. Moody’s also said that China would increase its deficit over the next few years to 3.3 to 3.5 percent.

The central authorities’ increasing struggles to stem Chinese currency from leaving the country mean that monetary policy support will not be as available in the event of a downturn, according to a Moody’s report earlier this month, adding that if the capital outflows persist then the banking sector could experience liquidity pressure.

Moody’s studied four potential transmission channels through which a property market downturn in China could have broader implications, according to Moody’s managing director Michael Taylor, who stated that these were supply chain linkages, impact on the banking sector, wealth effects and impact on government finances.

Credit Policies Steamroll China’s Real Estate Curbs

Moody’s’ comments on China’s leverage situation follow soon after reports that the country extended a record $1.84 trillion in loans in 2016 to support economic growth, half of which were household loans. This residential real estate lending helped send home prices to five-year highs, and these prices are continuing in 2017 despite curbs from municipal authorities around China.

In February home prices increased in 54 of China’s top 70 cities, jumping 12.4 percent from a year previous, according to data from the National Bureau of Statistics. However, cities around the country are taking action to curb rising house prices in order to stave off a building property bubble. Beijing late last week put in place eight new measures to cool the city’s property market, including a measure to stop so-called “fake divorces,” a process by which a couple divorces in order to purchase a home as a first-time buyer, thus being permitted to offer a much lower down payment.

Moody’s, however, did specify in its report that China’s rapid urbanization continues to support overall growth in the property market, adding that household affordability had strengthened over the period studied and that this was underpinned by a growth in household income.