China: Real Estate Sector Remains Main Source Of Financial Risk – Analysis

By Wei Hongxu

The international banking crisis has caused the domestic financial market in China to become cautious and concerned about the spread of external risks within the country, resulting in a shift from its previously optimistic expectations.

Despite this, most Chinese financial institutions have remained relatively stable, with only limited impact. However, researchers at ANBOUND warn that there are still many risk factors within the Chinese financial system, including the unresolved risks in the real estate sector and the accumulated debt of local governments related to real estate, which poses a significant threat to financial system stability.

Looking at the situation in the country, the impact of the international banking crisis mainly comes from two aspects. First, some related financial assets have experienced losses, which has led to actual devaluation for Chinese investors. This includes bank stocks of problematic banks such as Silicon Valley Bank and Credit Suisse, which have experienced significant depreciation. In addition, Credit Suisse’s write-down of some capital bonds has also led to corresponding losses for investors, and this affects the bonds issued by other banking enterprises. However, overall, the losses from such asset devaluation are not significant. At the same time, transactions and settlements with the “run” banks will be affected. However, with the measures taken by relevant regulatory authorities, these cash assets are still guaranteed, albeit possibly with some liquidity restrictions. As a result, the impact of external risks on China’s financial system is still limited, and this is why the country’s financial market remains relatively stable.

Noteworthily, Moody’s recently downgraded its outlook for the Chinese banking industry from “stable” to “negative”. The rating agency believes that the current Chinese economic recovery is still weak. At the same time, Moody’s analysts also warned that the asset quality of Chinese banks faces risks from non-performing loans. Therefore, the challenge of financial risk prevention mainly comes from within, and this is the reason why the Chinese central government has established the Financial Stability and Development Committee and the China Banking and Insurance Regulatory Commission to strengthen comprehensive supervision. Yi Gang, the Governor of the People’s Bank of China recently noted that “Overall, China’s financial industry is operating soundly, financial risks are generally under control, and the risks are manageable”. He emphasized the need to strengthen and improve modern financial supervision, enhance the financial stability guarantee system, promote the disposal of financial risks in key areas, maintain high pressure on illegal financial activities, strengthen the responsibility for risk disposal, and guard against the bottom line of systemic financial risks.

According to researchers at ANBOUND, both real estate and local debt can still be considered high-risk sectors related to China’s banking industry. While data shows that the Chinese real estate market saw a significant rebound in both investment and sales in the first two months of this year, it is worth noting that many real estate companies that suffered significant losses last year are still in the process of risk disposal. Additionally, under the support of local policies, the task of “guaranteeing delivery of houses” in the real estate market remains crucial, and the trend reversal of the real estate market still requires time. Data from the central bank indicate that long-term household loans increased by RMB 86.3 billion in February, a decrease of RMB 136.8 billion from the RMB 223.1 billion increase in January. At the same time, new home sales data in March also showed a “break”. This shows that the foundation of the real estate market’s recovery remains unstable. Recently, real estate company Sino-Ocean Group, listed in Hong Kong, announced that it will postpone the interest payment of its U.S. dollar perpetual subordinated bonds due on March 21. This indicates there is still considerable pressure on real estate companies’ refinancing this year.

In addition, there has been no apparent easing of fiscal pressure in the first two months of this year. The relaxation of the COVID-19 pandemic, combined with local efforts to accelerate economic recovery, does indeed lead to a normalization of fiscal expenditure growth in China. However, fiscal revenue remains sluggish. In the first two months, the national general public budget revenue was RMB 4564.2 billion, a year-on-year decrease of 1.2%, and the national general public budget expenditure was RMB 4089.8 billion, a year-on-year increase of 7%. Among them, the national general public budget revenue was RMB 2175 billion, a year-on-year decrease of 4.5%, and the local general public budget revenue was RMB 2389.2 billion, a year-on-year increase of 2%. National tax revenue decreased by 3.4% year-on-year. This means that domestic fiscal pressure has not yet eased this year, and there is a time lag between economic recovery and fiscal recovery. The decline in real estate-related tax revenue indicates that the recovery of the real estate market is not as optimistic as expected. In the first two months, the land value-added tax, urban land use tax, and deed tax related to real estate all decreased by 22.4%, 7.4%, and 4%, respectively.

Apart from the general budget, in January and February, the budget for national government-managed funds saw a year-on-year decline of 24.0%, with a decrease of 3.4 percentage points compared to last year’s annual decline due to the low base. The progress of the budget completion was only 8.9%, significantly lower than the five-year average of 12.4% for the same period. The main reason for the expanded decline in government-managed fund revenue was due to a 29.0% year-on-year drop in land transfer income, with a decrease of 5.7 percentage points compared to last year’s annual decline. On the expenditure side, the budget for government-managed funds saw a year-on-year decline of 11.0% in the first two months, with a decrease of 8.5 percentage points compared to last year’s annual decline. With the continuous rise of local debt and the pressure to “strictly control incremental implicit debt and resolve existing debt”, local government debt risk in China this year will magnify the risk of the real estate market, bringing greater pressure to the financial system.

Looking at the banks affected by the crisis overseas, the main reason for their predicament is the devaluation of assets such as government bonds and MBS bonds under the Federal Reserve’s interest rate hike. If this further affects the U.S. real estate market, a large number of related assets may be re-evaluated, leading to a new round of financial crisis. Similarly, the fluctuation in the value of China’s real estate assets will also directly impact its domestic financial system. Therefore, the risk of the Chinese real estate market, as well as the local debt risk brought about by the transition from “land finance”, are still the “gray rhinos” that the Chinese financial system needs to face at present.

Final analysis conclusion:

Despite the ongoing banking crises overseas, China’s financial system has not been severely impacted by external factors, and the main sources of financial risk still lie within the country. The risks posed by the real estate market, coupled with the related issues of local government debt, continue to be the primary sources of systemic financial risks in China.

Wei Hongxu is a researcher at ANBOUND

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