China's economy barely grew in Q2 as the full lockdown in Shanghai and many other cities brought activity to a grinding halt. Frustration with the country's stop-start emergence from Covid is beginning to boil over, in the form of a mortgage boycott spreading across the country.
This week, homebuyers at some 230 property developments across 86 cities have joined together in refusing to make their mortgage payments on apartments that are under construction, demanding that they see progress on the projects. Developers have received "mortgage repayment suspension notices" issued by customers, with homebuyers accusing developers of misusing the proceeds, and accusing banks of releasing mortgage proceeds before the projects top out. More on that later.
Overall, GDP grew 0.4% compared with the same time last year, the National Bureau of Statistics of China reported on Friday. That was far worse than the 1.2% growth economists had forecast.
Services activity was particularly poor, with that sector shrinking 0.4%. Primary production rose 4.4%, with China using factory output as a way to sustain jobs and stimulate activity. Overall, activity in Q2 shrank 2.6% from Q1.
It could have been a lot worse were it not for a strong end to the quarter. "The June activity data mostly surprised on the upside, thanks to a complete normalization of supply chains and some pent-up domestic demand," Société Générale's China economists Wei Yao and Michelle Lam write in a note to clients. "The question next is then whether the demand recovery can sustain."
Covid flareups and the sharply deteriorating housing market suggest that the recovery is "wobbly, at best," they conclude. China's zero-Covid stance leaves cities at risk of sudden shutdown, and new-case counts have once again started to rise. Consumers have all but stopped making big-ticket purchases like cars and apartments.
The boycott movement on mortgages has been growing since the start of this month. It's hitting the economy's most-important sector, and the prime way in which Chinese people store wealth.
Housing is the largest sector in the Chinese economy, a market worth some US$55 trillion including existing stock, or three times the US$17.7 trillion total GDP for 2021. That means the housing stock in this country of 1.4 billion is larger than the United States. Property agency Zillow estimated in January that the U.S. housing sector is worth US$43.4 trillion.
The mortgage-refusal movement affects developments by both unlisted and major listed developers. The suspension has hit projects by China Aoyuan Group HK:3883, China Evergrande Group (EGRNF) and HK:3333, Fantasia Holdings HK:1777, the Greenland group HK:0337, Kaisa Group Holdings (KAISY) and HK:1638, Shimao Group Holdings (SHMAY) and HK:0813, Sinic Holdings HK:2103, Sunac China Holdings (SNCHY) and HK:1918, and Yango Group SZ:000671. Evergrande, the world's most-indebted developer, has at least 27 projects that have been hit.
A growing number of cities are affected, including Shenzhen, Wuhan, Xian and Zhengzhou, the capital of Henan Province. State-owned bank CCB International estimates that five million households are involved on mortgages worth around C¥2 trillion. There's currently 107 billion square feet of residential space under construction in China, according to CCB. If 5% of that total is affected, it's equivalent to around 5.4 billion square feet.
The trend has been snowballing this month. Although the developers that are already in the most financial distress are worst-affected, "we believe the recovery of homebuying sentiment will be affected, and other less-distressed developers are at peril of contagion risk," CCB analysts Lung Siufung, Elena Chen and Lawrence Chen say.
Developers are supposed to hold homebuyer deposits of 5% to 10% of the purchase price in escrow before the projects are delivered. But some developers "were said to have misappropriated the funds" to finance construction or repay debts, according to the Global Times newspaper.
That's effectively how they used to operate. They previously took deposits on "presale" apartments, which are sold off-plan before they are built, using the cash to fund development. But the Beijing government's bid to force the sector to deleverage has outlawed the practice, requiring deposit cash to be held in escrow. It cuts off a key source of liquidity for the developers.
There's always a temptation, therefore, for developers to illegally tap the deposit piggybank, just as they used to do, if they can find cooperative local bankers. The system works fine if property prices keep going up and projects proceed quickly. It all comes undone when prices move in reverse and activity stops, as has happened now.
It's unclear how badly developers and mortgage-issuing banks will be affected. But the boycott "is likely to damage the already-weak sentiment towards the residential mortgage business in the near term," CCB says, with mortgages making up around 20% of the total loan book for banks.
The housing boycott has received significant coverage in local media in China, although not the state-owned press. Nomura notes that "the movement itself has clearly evolved into a major social incident with the potential to trigger social unrest." The national government will undoubtedly therefore have to step in, Nomura property analysts Jizhou Dong and Stella Guo conclude, with the issue requiring "the government's urgent attention and action."
The Global Times, used as China's foreign-policy mouthpiece, has covered it obliquely. It notes only that there have been problems with presale homes in Henan Province, and "isolated incidents that also sparsely occurred in other provinces." The Global Times blamed "inadequate oversight of presale funds" for problems with housing projects.
Henan Province is being hung out to dry. It has already been criticized because officials there began doctoring the health-code system on citizens' mobile phones. After Henan residents went to Zhengzhou to protest their inability to withdraw money from several troubled local banks, or to protest unfinished property projects, they found that the health codes on their phones turned red, although they hadn't had any Covid exposure. Such a code makes it impossible to travel. Five Henan officials have been punished for abusing the health-code system to prevent protests.
Beijing may respond with emergency funding to push partially completed projects through to completion. Homebuyers may have to agree to resume payments for their projects to receive the funding.
The question is where the cash will come from. Local governments already have extremely stretched finances - they used to get a large proportion of their budgets from land sales, which are often floundering due to the financial problems at developers. State-owned enterprises may take over troubled projects, or even buy out the developers that are in the most distress. But the central People's Bank of China as well as the Ministry of Housing and Urban-Rural Development "will also need to step in with liquidity support," Nomura's Dong and Guo say, as well as coordinating with local governments.
CCB says that as a result, it is increasingly conservative when it comes to investment in the Chinese property sector. A handful of well-capitalized developers such as state-owned China Overseas Land & Investment (CAOVY) and HK:0688, China Vanke (CHVKY) and HK:2202, Yuexiu Property HK:0123 and the private Midea Real Estate Holding HK:3990 are "still relatively immune to construction or mortgage suspension given their healthy financial position," the bank states.
Developer share prices, already trashed by the spiraling problems affecting Evergrande and a dozen or so other major developers, have fallen 20% to 25% in the last week. Although there could be a squeeze on sellers if Beijing steps in with policy support, resulting in a sudden share-price boost, Nomura warns that it has a bearish view on the stock of privately-held developers in the long run. Many private property companies are likely to see their market share shrink.
Separately, the State Council, China's equivalent of a cabinet, is introducing policies designed to sustain payrolls and boost job creation. Premier Li Keqiang says "the government must continue to put employment front and center, and do everything possible to stabilize and increase jobs."
Li has regained his prominence during April's downturn as President Xi Jinping took a back seat. Xi had introduced a string of Maoist-tinged policies targeted at "common prosperity" that began to look like an attack on the private sector as a whole. As China's economy faltered, he has backed off those efforts.