Property market woes focus fiscal power in Beijing

“Never let a good crisis go to waste,” an aphorism ascribed to Winston Churchill, might be the watchword for China’s Communist Party as it prepares to select a new round of leaders at its 20th Congress in November. A piece of political theater that might have come out of imperial annals of the first millennium BCE illustrates deep changes at work in China’s power structure. Four rural banks in China’s Henan province stopped paying out deposits in May, prompting hundreds of angry local residents to demonstrate in front of the bank’s offices. On Monday, white-shirted men showing no official identification attacked the demonstrators, and videos of the incident went viral on Chinese social media. But on July 12 China’s banking regulators announced that depositors would be paid starting July 15. It turns out, Chinese media report, that a “criminal gang” was to blame for the failure of the four banks. Caixin Global Daily wrote: Initial investigations found that a criminal group led by the controlling shareholder of private company Henan Xincaifu Group Investment Holding Co Ltd is suspected of using the village banks to carry out illegal deposit-taking since 2011. The gang is thought to have gained control of the lenders through illicit means, sold financial products through their own platform, and set up shell companies to conceal information, the police said. Authorities arrested several dozen people linked to the scandal. At least three officials from Henan and local banking regulators are also under investigation, according to Henan graft busters. All of China’s 1,600 rural banks together hold under 1% of the country’s banking assets, so the economic impact of the Henan scandal is vanishingly small. But as an exemplary tale, it became a top news item: As so often in Chinese legend, the good emperor has intervened to protect honest citizens against wicked provincial officials. Of far greater consequence is the collapse of the independent financial base of most of China’s provincial governments. China’s property market shakeout has centralized financial power in Beijing for the first time since the Deng Xiaoping reforms began in 1979 – achieving a longstanding objective of Chinese reformers that had been successfully thwarted in the past by powerful regional party organizations. The collapse of land sales in the wake of widespread distress among China’s property companies has left provincial governments desperately short of funds and beholden to the tax and borrowing power of the central government. Except for the home equity loan market during America’s 2008 crisis, the collapse of China’s property bond market ranks as the worst in the history of any of the world’s major economies. Bloomberg’s China Yield Bond Index, which measures the value of US-dollar-denominated bonds issued by Chinese companies, has lost more than two-thirds of its value since May, as one major developer after another failed to meet coupon payments. Two-thirds of the bonds in the Bloomberg Index are trading at dollar prices below $50, which indicates a high probability of default. The visible pain in the property market is mirrored in the financial condition of China’s local governments. Land sales by local governments in the first half of 2022 fell to US $211.8 billion, a 55% decline from a year earlier, according to data compiled by China Industrial Securities. That cut local government revenues by roughly half. In 2021, land sales made up 41.6% of revenues, not counting taxes generated from sales of land. Private developers are unable to bid because they lack funds. State-owned enterprises accounted for 73% of all land sales during the first half of 2022 according to a report from China Real Estate Information Corp cited by Caixin Global Daily. Beijing will permit local governments to use next year’s special bonds issuance quota immediately to counteract the fiscal blow to local governments. In the second half of this year, local governments may be allowed to sell 1.5 trillion yuan (US$220 billion) of special bonds on top of their granted quotas for 2022. If that is implemented, it will be the first time that the central government has allowed local governments to use future borrowing quotas half a year in advance. In the past, local governments were allowed to use the following year’s borrowing quotas no earlier than November.  The reported proposal to accelerate local government borrowing came after Premier Li Keqiang chaired a State Council meeting on June 29, and urged local authorities to start their infrastructure projects as early as possible to create jobs. Li also said the central government would issue 300 billion yuan of bonds to help important infrastructure projects replenish their capital or facilitate local governments to issue special bonds. The People’s Bank of China began the shakeout in the property market in December 2020, by placing a cap on property loans a

Property market woes focus fiscal power in Beijing

“Never let a good crisis go to waste,” an aphorism ascribed to Winston Churchill, might be the watchword for China’s Communist Party as it prepares to select a new round of leaders at its 20th Congress in November.

A piece of political theater that might have come out of imperial annals of the first millennium BCE illustrates deep changes at work in China’s power structure.

Four rural banks in China’s Henan province stopped paying out deposits in May, prompting hundreds of angry local residents to demonstrate in front of the bank’s offices. On Monday, white-shirted men showing no official identification attacked the demonstrators, and videos of the incident went viral on Chinese social media. But on July 12 China’s banking regulators announced that depositors would be paid starting July 15.

It turns out, Chinese media report, that a “criminal gang” was to blame for the failure of the four banks. Caixin Global Daily wrote:

Initial investigations found that a criminal group led by the controlling shareholder of private company Henan Xincaifu Group Investment Holding Co Ltd is suspected of using the village banks to carry out illegal deposit-taking since 2011. The gang is thought to have gained control of the lenders through illicit means, sold financial products through their own platform, and set up shell companies to conceal information, the police said. Authorities arrested several dozen people linked to the scandal. At least three officials from Henan and local banking regulators are also under investigation, according to Henan graft busters.

All of China’s 1,600 rural banks together hold under 1% of the country’s banking assets, so the economic impact of the Henan scandal is vanishingly small. But as an exemplary tale, it became a top news item: As so often in Chinese legend, the good emperor has intervened to protect honest citizens against wicked provincial officials.

Of far greater consequence is the collapse of the independent financial base of most of China’s provincial governments.

China’s property market shakeout has centralized financial power in Beijing for the first time since the Deng Xiaoping reforms began in 1979 – achieving a longstanding objective of Chinese reformers that had been successfully thwarted in the past by powerful regional party organizations.

The collapse of land sales in the wake of widespread distress among China’s property companies has left provincial governments desperately short of funds and beholden to the tax and borrowing power of the central government.

Except for the home equity loan market during America’s 2008 crisis, the collapse of China’s property bond market ranks as the worst in the history of any of the world’s major economies. Bloomberg’s China Yield Bond Index, which measures the value of US-dollar-denominated bonds issued by Chinese companies, has lost more than two-thirds of its value since May, as one major developer after another failed to meet coupon payments.

Two-thirds of the bonds in the Bloomberg Index are trading at dollar prices below $50, which indicates a high probability of default.

The visible pain in the property market is mirrored in the financial condition of China’s local governments. Land sales by local governments in the first half of 2022 fell to US $211.8 billion, a 55% decline from a year earlier, according to data compiled by China Industrial Securities. That cut local government revenues by roughly half.

In 2021, land sales made up 41.6% of revenues, not counting taxes generated from sales of land. Private developers are unable to bid because they lack funds. State-owned enterprises accounted for 73% of all land sales during the first half of 2022 according to a report from China Real Estate Information Corp cited by Caixin Global Daily.

Beijing will permit local governments to use next year’s special bonds issuance quota immediately to counteract the fiscal blow to local governments. In the second half of this year, local governments may be allowed to sell 1.5 trillion yuan (US$220 billion) of special bonds on top of their granted quotas for 2022.

If that is implemented, it will be the first time that the central government has allowed local governments to use future borrowing quotas half a year in advance. In the past, local governments were allowed to use the following year’s borrowing quotas no earlier than November. 

The reported proposal to accelerate local government borrowing came after Premier Li Keqiang chaired a State Council meeting on June 29, and urged local authorities to start their infrastructure projects as early as possible to create jobs. Li also said the central government would issue 300 billion yuan of bonds to help important infrastructure projects replenish their capital or facilitate local governments to issue special bonds.

The People’s Bank of China began the shakeout in the property market in December 2020, by placing a cap on property loans at China’s lenders. This and related measures to restrict credit to the property market slowed the rate of increase of both property loans and housing prices. A combination of Covid-19 pandemic effects and buyer caution effectively froze property sales.

That was Beijing’s objective.

First, rising home prices represented an intergenerational wealth transfer to older Chinese who already owned homes, from younger Chinese who could not afford homes. In booming Shenzhen, the average apartment cost 36 times the average annual income. In the western city of Chengdu, a modern and livable metropolis, a central apartment cost about 20 times the average income, and about half that in the suburbs.

Lower home prices – or at least smaller increases in home prices – were viewed as a beneficial political outcome by the Communist Party, which is also building more subsidized public housing.

Even more important, though, is the shift in the political configuration. The great migration of 600 million Chinese from countryside to city during the past forty years produced an enormous swell in real estate values, as China built the equivalent of all the cities in Europe from the Urals to the Atlantic to house the new urbanites. That produced vast amounts of wealth for property developers in China’s provinces, and the opportunity for cronyism between local officials and real estate interests.

Beijing has wanted to rationalize government finances, funding government operations from normal tax collection and government debt issuance on the model of Western industrial countries. The property crisis instigated by Chinese regulators and intensified by the Covid epidemic gave Xi Jinping the opportunity to push through what years of committee meetings had failed to accomplish.