MP Econ Issue 8: PBOC Steps in to Loosen Policy on Property Sector
As we had anticipated last week, the People’s Bank of China (PBOC) has begun taking actions to stabilize the property sector. On September 27, the PBOC sent a public message that it wants to ensure “the property sector’s healthy development,” marking the first time in a decade the property sector has been mentioned in the central bank’s quarterly policy statements.
Just two days later, the PBOC summoned regulators and 24 heads of major banks to a meeting on the property sector situation. During the meeting, the PBOC instructed the banks to work towards stabilizing the sector, which we interpret as a fairly clear signal to suspend or reverse recent mortgage tightening measures.
At the same time, Beijing is working to ensure homebuyers’ confidence in presales, which as noted previously, is the largest source of revenue for property firms. This explains recent mandates for property developers to deposit at least a third of their presale revenue in special escrow accounts that are supposed to be used toward construction.
Although such a policy has been in place since the 1990s, its enforcement has been lax. As a result, cash-strapped developers have been known to illegally withdraw escrow money for other purposes. These practices tended to be localized, but the Chinese government is not taking any chances at the moment. It is now strengthening the escrow account enforcement nationally, requiring that money to be only used toward construction in a bid to sustain the confidence of buyers in receiving their presale units.
This applies as much to Evergrande as the entire property sector writ large. Currently, Evergrande has more than half a million presale units across the country that face the risk of not being completed for many years. It also marks the first time a top property firm cannot deliver on presale units. Beijing does not want this replicated across the sector, and so it is focused on making sure that property firms will be able to honor as many presale units to as many buyers as possible.
If the escrow account mandate is effective, that should allow companies like Evergrande to restart currently suspended projects, which would go a long way toward maintaining consumer confidence. That consumer confidence in presales is crucial to sustaining the cash flow of all major property firms, which will in turn lead to more sustained sales overall and improve the financial health of developers.
Therefore, the extent to which housing sales rebound over the next few months will be a strong leading indicator of the resolution of the current liquidity crisis in the property sector. If these policies are effective in stabilizing the property sector by the end of the year, Beijing will become less directly involved in the Evergrande situation.
At that point, banks would be allowed to start demanding repayment from Evergrande, which will likely lead to the company’s restructuring. For now, however, banks have been sidelined because Beijing has told them that they should be more patient on collecting debt payments from Evergrande, allowing the company to prioritize dealing with bondholders, suppliers, and retail investors first. Although the banks are the most powerful among Evergrande’s creditors, Beijing can exert more control over them than over the other constituencies.
Once the immediate situation is contained, don’t expect Beijing to do a U-turn on deleveraging. In fact, the government will simply close loopholes in current regulations and continue to pursue deleveraging of the property sector.
The latest problems stem from the property sector experiencing the double whammy of deleveraging and policies that stifle sales. Now that the PBOC appears to revert to policies that will facilitate sales, the effect of deleveraging on the entire sector should be modest. For example, property investment had been stable even after deleveraging started in late 2020. As long as a rebound in sales becomes evident over the next few months, regulators appear to believe that the sector can withstand deleveraging.
Put another way, the Chinese government is focused on preventing the Evergrande fire from becoming a conflagration, while continuing to discipline the sector to prevent a return to its old normal of debt-fueled growth.