China is home to 1.4 billion people, a major producer and consumer of goods and commodities and a leading engine of global economic growth. Clearly, what happens in mainland China matters.
So, when we see a slowdown in China’s property markets, it is important to understand what impact this could have on the UK.
For years, property development has been a catalyst for China’s economic growth, with Goldman Sachs reportedly putting the total value of Chinese homes and developers’ inventory at $52trn (£38trn) in 2019.
This is set to change. The Chinese government has signalled a desire to rebalance the economy, increasing the importance of domestic consumption and reducing reliance on infrastructure and property investment.
In 2020, measures to support the re-allocation of capital away from property to other sectors of the economy, and to address high indebtedness among developers, were introduced.
The Three Red Lines Policy linked access to future finance to strict criteria, including a liability-to-asset ratio of less than 70%, a net gearing ratio of less than 100% and mandating cash to short-term debt ratios. Compliance with all three rules rose from just 10% of developers in the first half of 2020 to nearly 40% by the of end of the year.
Evidence suggests these measures designed to restructure the market are working. The latest data from China’s National Statistics Bureau suggests construction and real estate activity has started to stabilise and Bloomberg Intelligence estimates apartment prices fell 24% in the year to October 2021.
In the UK, construction cost inflation is the main challenge for developers. Supply chain disruption, changes to border controls, labour shortages and the energy market price shock have created the most challenging inflationary environment in living memory. The near-term outlook points to further rapid inflation as the lagged impact of some of these factors continues to work through the supply chain.
Mounting risks
All this raises the question of whether a slowdown in China’s property markets could help to ease construction cost pressures in the UK. The short answer is yes… potentially. Some traded metals and other commodities prices have started to fall to a more stabilised level and a weaker outlook for demand from China is a driver.
Contractors are reporting a reasonably healthy pipeline and capacity utilisation, but risks are mounting. Tender prices are forecast to rise fairly robustly in 2022, but the outlook is highly uncertain. It wouldn’t take much to tip the viability balance. Recent falls in commodities prices may eventually provide some respite, giving headroom for commercial decisions to be taken.
This all assumes the Chinese government’s desired objective to deliver controlled rebalancing is achieved. We can’t ignore the risk that this managed restructuring leads to a more disorderly default by some of the world’s largest, and most indebted, firms. Analysts deem the risk of this worst-case scenario occurring to be pretty low. But if the worst happens, the US Federal Reserve has warned the implications for the global financial system could be serious.
Despite the challenges at a global level and the slowdown in China, there may be some respite from the input costs resulting from the managed slowdown and if in the UK we watch these events carefully, we’ll be able to make decisions on the front foot.
James Barton is director at AECOM
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