Sino Strategies: China's Influence & its Implications for the U.S.

On October 10th, Country Garden Holdings, one of the largest real estate developers in China, announced via the Hong Kong Stock Exchange that it was not able to repay a loan and is expecting to miss upcoming overseas debt payments. Indeed, decreasing revenues in the PRC’s real estate sector are the likely source of this missed debt payment. Country Garden’s financial woes make it the latest in a series of Chinese real estate development groups to suffer the stress of an unstable property market, particularly following China Evergrande Group’s 2021 default.

The PRC’s real estate development market has contributed significantly to China’s economic growth, accounting for roughly 25% of China’s GDP during the 2010s and as much as 30% of the PRC’s overall economy. In spite of Beijing’s domestic efforts to boost the economy – including such initiatives as the National Day Golden Week holiday – the market crisis has had, and will continue to have, a significant impact on China’s economic growth and overall stability. What’s more, left unchecked, a deepening crisis will further aggravate repercussions globally. This article takes a closer look at China’s real estate development crisis and considers how U.S. policymakers, businesses, and consumers could respond to Country Garden’s potential default and prepare for future headwinds in China’s real estate sector.

China’s property development market

As mentioned above, the real estate development sector has been an important driver of China’s economic growth over the last three decades. The expansion of this sector enabled the PRC to accommodate a rising urban population and urban population density. China’s real estate expansion and urbanization contributed greatly to improved living standards and economic well being for the Chinese people. Indeed, home ownership is the Chinese consumer’s most substantial asset. A 2019 survey conducted by the People’s Bank of China on urban households showed that housing assets made up 59% of households’ total assets, with mortgage loans standing at 12% of total assets. These figures are similar to those of U.S. borrowers in 2008 on the eve of the subprime mortgage crisis. 

In August 2020, against the backdrop of a flourishing property market – and the accompanying high levels of debt – Beijing instituted a set of real estate sector regulatory guidelines called the “Three Red Lines” in August 2020. The purpose of the “Three Red Lines” is to set limits on three debt measures for a group of real estate developers. The institution of this policy, along with China’s already structurally imbalanced housing market and a weakened economy resulting from Beijing’s COVID-19 response, created a perfect storm for market correction. In particular, Evergrande failed the Three Red Lines test ahead of its default. 

Enter Country Garden, China’s largest private real estate developer. The embattled company’s sales fell from 523 billion RMB in 2021 down to 430 billion RMB in 2022, for a drop of nearly 20%; and in the same time frame profits fell from 40 billion RMB to -2 billion RMB. In light of Country Garden’s missed debt payments, the company’s founding family loaned $300 million interest free to support its liquidity. 

What’s next for the real estate market in China

Beyond the increased risk in the real estate development sector, continued instability in this sector could cascade into other areas as well. The real estate sector is a pivotal node in China’s overall economy. Real estate development has direct connections to the construction sector, the architecture and design sector, the materials sector, the financial sector, local governments, and individual household wealth. 

The construction sector is especially closely tied to home value. Instability of the latter could lead to decreased output and increased employment challenges in the former – which, at its peak in 2020, provided over 60 million jobs. 

While Chinese household wealth is tied primarily to home value, continued volatility in the real estate market could put Chinese people’s economic welfare at risk. Additionally, many local Chinese governments created financing vehicles (LGFVs) that borrowed capital from banks using mostly land as collateral. If land prices fall steeply, investors in LGFV bonds could face higher default risks.  

For China, stabilizing the property sector will likely require a combination of short-term interventions and longer-term restructurings. In the short term, state and local governments will likely continue to intervene in the market in an effort to prevent other property players from missing debt payments. In the longer term, China’s economy will have to be reorganized, and growth will have to be enabled by consumer goods spending rather than the real estate market. 

Implications of Country Garden’s Situation for the United States

1. U.S. Policy Implications

China is one of the U.S.’s largest trading partners, purchasing billions of dollars of American crops and machinery each year. A weakened Chinese economy means a slowdown in demand for oil, raw materials, and other industrial commodities. Thus, the U.S. has much to gain from increased stabilization of China’s real estate market. In particular, for U.S. policymakers, stabilization of China’s property market will require short-term support and longer-term engagement with Beijing. 

In the short term, Washington will have to continue to prioritize diplomatic engagement with Beijing and close collaboration with allies in the region. Concerted engagement with multilateral institutions such as the United Nations, International Monetary Fund, and the World Bank will enable a streamlined and effective policy response. Coordination with regional institutions such as the Quad and ASEAN will ensure that regional supply chains experience minimal disruptions and that local economies can adjust swiftly and efficiently policies in concert with one another, enhancing the region’s overall economic resilience. 

In the longer term, policymakers should seek to diversify supply chains, investments, and economic partnerships. This can be achieved by working more closely with developing nations to build robust alternative supply chain networks and investment plans. It could also involve subsidies and incentives for businesses and consumers to spend domestically and seek out non-Chinese players along the value chain going forward. 

2. U.S. Business Implications

A decline in consumer spending in China hurts companies that do business there, including American technology firms and luxury consumer goods groups. Additionally, because of China’s global economic reach, volatility in China’s real estate development sector impacts the global economy. Therefore, China’s property market woes will likely have significant ramifications for most U.S. businesses, whether they have market presence in the PRC or not. 

To hedge against the risk of a worsening Chinese property market, U.S. businesses could consider decoupling supply chains away from Chinese players as possible, for reasons similar to those mentioned above. To this end, businesses could consider working more closely with players from other countries in the region, especially in South East Asian, to minimize the geographical impact of a supply chain coupling. 

The corporate response could also involve strengthening of contractual agreements with suppliers and value chain players. Businesses could include provisions that address potential disruptions in the supply chain due to economic challenges in China, and legal counsel can help ensure that contracts provide adequate protections and flexibility. Crisis planning inventory management could also enhance supply chain resilience against potential real estate challenges emanating from the PRC. 

3. U.S. Consumer Implications

In the U.S, the real estate sector is experiencing high home prices, high mortgage rates, and high costs of borrowing. Rate and cost stabilization is an essential driver of housing market activity. Continued instability in China’s real estate sector will obstruct rate and cost stabilization of real estate sectors globally, thus limiting activity in the U.S. Real estate developers and homeowners in the U.S. may have to watch global real estate markets closely to monitor risks accelerated by the PRC’s real estate sector.

U.S. consumers could also consider diversifying their portfolios. Balancing out real estate investments, foreign assets, and risky holdings with safer investments such as U.S. Treasury bonds or high-grade corporate bonds could help mitigate the impact of an exacerbated Chinese housing market downturn.