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Article by Sameer Chowdhry
With the second largest economy in the world, China’s property sector, which accounts for a third of its economy, has experienced massive troubles. Over the last three decades, the property sector has become an engine for China’s economic growth. With low interest rates and easy access to credit, China’s building boom met the needs of a growing population, providing employment, houses, and a place to store your savings. However, this exponential growth is characterised by excessive borrowing and overbuilding by developers; coupled with the impact of Covid-19 and government policies, this growth has recently come to a halt. As a result, these effects have rippled through the wider economy, trickling down to affect investors, businesses, and consumers alike.
China’s Current Crisis
China’s current real estate market crisis could be attributed to the bankruptcy of Evergrande in 2021, racking up $340bn of liabilities to become the world’s most indebted property developer at the time. Expanding aggressively to become one of the country’s biggest companies, Evergrande became a victim of the new government policies at the time. To stop the risky practices such as excessive borrowing in the industry, China’s government introduced the ‘three red lines’ in 2020, accounting measures to limit how much developers could borrow. This subsequently impacted the liquidity of banks, especially those already engulfed in debt. Combined with Covid-19 restrictions limiting the appetite of both investors and consumers, the lack of demand for units alongside the rising interest payments on its debt, meant the heavily indebted company filed for bankruptcy shortly after.
Country Garden, China’s biggest private sector developer, defaulted on its overseas debt in late 2023, adding to the concerns about China’s property sector. Racking up $200bn in unpaid bills, the default was the latest big name collapse since Evergrande in 2021. Since 2020, more than 50 real estate developers in China have failed to keep up with their payments, signifying the slow deterioration of the once rapidly expanding sector. Authorities fear that this will spill over to the broader economy, especially the wider financial markets, delaying the recovery of the real estate industry still recovering from the effects of the pandemic.
To say that the crisis has massive implications is an understatement. Firstly, the ripple effect of the potential collapse could destabilise not only China’s financial system but also impact the global financial markets. For instance, in August 2023, investors pulled $7.5 billion from Chinese stocks as China’s Foreign Direct Investment dropped to a new low by the end of the year. Moreover, the potential slowdown in economic growth caused by the crisis could impact the global demand for commodities such as steel and cement, impacting global supply chains. consequently, companies will sell fewer products and revenues will decrease, especially those reliant on selling to China. Therefore, international investors with considerable exposure to China may face huge upcoming challenges.
Furthermore, the crisis brings about widespread uncertainty, especially amongst consumers and investors. With many Chinese families taking on substantial mortgages to purchase homes, they are especially vulnerable to the economic downturns in this case. As a result, there has been a decline in consumer confidence, and in turn, consumer spending in relation to home sales and domestic consumption. In addition, local governments in China often rely on land sales and property development as a major source of revenue, further complicating this web of debt. Not only will local governments receive decreased revenue, but developers will be deprived from the financing required to meet their payments due to a lack of consumer demand. With government policies reducing the amount real estate developers could borrow, many developers will experience liquidity problems, resulting in bankruptcy.
In relation to law firms, restructuring and insolvency lawyers will advise those developers that have entered bankruptcy. This will entail managing negotiations with relevant creditors, ensuring legal compliance throughout the process. The wider banking team may help those companies experiencing potential liquidity issues through refinancing debt to meet the rising interest payments. Lawyers will also be involved in distressed M&A deals, referring to the sale or purchase of assets of a business in financial difficulty. Larger companies may see this crisis as an opportunity to acquire smaller struggling companies in order to consolidate their market share within the industry. In addition, given the economic uncertainty amongst investors, disputes relating to trade and investments are likely to increase. With potential contracts not being fulfilled, lawyers will need to advise relevant parties on potential litigation or arbitration routes.
To conclude, it is clear that China is in uncharted territory at the moment. Its real estate crisis has the potential to impact both the domestic and global financial system. For law firms, this crisis underscores the need for lawyers to help companies and institutions navigate their next steps in the wake of this uncertain world.