When speaking about risks to China’s real economy, many commentators are getting distracted.
Over the last several months, Beijing’s botched stock market reform and concerns about China’s currency regime have dominated headlines and commentary in many media outlets.
But while both of these items are certainly important in the context of the government’s ongoing rebalancing efforts, they have drawn attention away from the factor that continues to pose the single greatest threat of disruptive slowdown to the Chinese economy—the real estate market.
Shifts in China’s property market deserve more attention than shifts in the stock market or the exchange rate. Unlike stock markets in Europe and the US, the stock market in China accounts for a relatively small portion of household wealth and company funding. As a result, its recent declines have had a much smaller impact on the real economy than similar declines would have in Western countries.
Likewise, the exchange rate, while important, is not critical to the health of large portions of the real economy. Barring a shift several times larger than the devaluation the yuan recently experienced, the impact of further adjustments will largely be confined to the country’s export industries.
In contrast, China’s property market is heavily tied into the real economy. It undergirds the country’s growth in three ways:
- Large groups of companies are highly reliant on the real estate sector. When the raw materials and finished goods that feed into property development are included in calculations, the sector accounts for 25 to 30 percent of China’s GDP.
- The financial sector is heavily exposed to the real estate market. Current estimates suggest that 40 percent of banks’ loan books are secured by mortgages and 10 percent are secured by land.
- Consumers are highly leveraged to the real estate market. Property holdings account for the majority of household wealth in China, significantly more than bank deposits or investment products.
Unfortunately, the support that the real estate market currently offers the economy is shaky at best.
The threat of China’s property market
China’s property market will pose a threat to the economy for years to come. Outside of its top-tier cities, housing supply greatly outstrips demand. This is largely due to rampant overbuilding in the country’s lower-tier cities, which account for around 90 percent of floor space sold. Unfortunately, this mismatch is unlikely to disappear anytime soon. According to a recent study by the IMF, China’s housing market will be overcapacity until at least 2020.
As long as the property market adjusts in an orderly manner, its overcapacity will simply exert a steady drag on Chinese growth. If, however, the property market experiences a disorderly adjustment, the effects will be difficult to contain. Numerous companies that rely on the real estate sector will go under, banks will tighten credit to account for the devaluation of half their collateral, and consumers will see their greatest store of wealth wiped out.
The combined impact of these shocks would overshadow the impact of another stock market correction or another currency devaluation by a large margin. Executives should keep this in mind the next time they are wading through the headlines on China’s recent reform efforts.
For more information on China’s economic prospects and how a sharp slowdown would impact countries around the world, see our recent report on the topic, available here.