China walks a fine line in curbing excesses without sinking growth

As part of a broader effort to combat growing income inequality and economic imbalances, Chinese policy-makers have sought to rein in real estate speculation — risking slowed growth or touching off a credit crisis, analysts warn.

According to a new report from DBRS Morningstar, China’s property sector has been a key source of economic growth for the past 20 years. Yet, in the process, both developers and households have taken on ever-larger debt loads.

Recently, policy-makers in China have taken action to reduce the growing reliance on the property sector, cool the market and preserve financial stability.

Yet, this action carries risks too, as evidenced by the turmoil touched off by the near default of the country’s largest developer, Evergrande Group.

“Regulatory tightening is the key reason for the stresses in the property sector,” the report said.

The recent Evergrande crisis highlights the fine line that policy-makers must walk between curbing leverage in the economy and preserving financial stability.

“Stress could spread to other parts of the economy and the financial system if policy easing is too cautious,” noted Fitch Ratings in a report.

“However, a substantial loosening of credit conditions could raise system leverage and set back efforts to control financial risks,” it said.

The delicate task of deleveraging the property sector “will test China’s willingness and ability to avoid a broader credit crunch and a crash in property prices,” DBRS said.

A shift toward more balanced growth “entails material downside risks in the near term,” the report said.

“The fallout from developments around Evergrande could have unanticipated effects that spread through the financial system and economy, potentially leading to sharply lower growth prospects over the next few years,” it warned.

DBRS said that, while the country’s financial sector likely has the capacity to ride out increased credit losses, “it is less clear how the government will respond to declining property prices or the drop in real estate activity, and the implications these might have for the Chinese economy and politics.”

Fitch said it doesn’t expect a sharp correction in housing prices that could produce financial instability or depress medium-term growth, but policy-makers will likely face mounting pressure to boost credit growth and possibly ease regulatory restrictions in the real estate sector before the end of the year.

For now, Fitch continues to believe that China will see 8.1% growth this year and 5.2% in 2022.

“However, if policy moves are insufficient to bolster confidence, challenging refinancing conditions and subdued housing sales may persist for some time,” it said.

“This would not only introduce considerable risks to our baseline growth outlook, but could also aggravate macro-financial risks, in light of the real-estate sector’s hefty share in corporate borrowing and economic activity.”