Reducing leverage to strengthen long-term stability

While much attention has been paid to the default risks of Chinese real estate developers amid the country's deleveraging moves, few have noticed the other side of the coin: There has been solid headway made in resolving the sector's long-lasting debt problem.

The falling debt burden of the real estate sector－a key source of the economy's debt as a whole－will not only cement long-term financial stability but increase the room for macro policy to support economic growth next year.

Financial vulnerability is rooted in high leverage. For years, China's real estate developers have operated at a high leverage rate, borrowing heavily to invest and relying on refinancing and property sales for repayments.

The model proved efficient during good times for the property market, but it carries the inherent risk of liquidity strains and debt defaults when expectations of ever-rising property prices are shaken. It can dampen property sales and make refinancing more difficult for developers.

That is partially why the government strengthened efforts to deleverage the sector last year, enacting limits on some developers' debt levels and caps on bank loans to the sector.

The efforts have borne fruit. The weighted average net debt-to-equity ratio－a key indicator of corporate debt levels－of 80 major Chinese listed developers had dropped by 4.53 percentage points year-on-year to 66.54 percent by the end of June, according to China Real Estate Information Corp, a property data provider.

The deleveraging process has been uncomfortable for some of the most indebted developers, especially those who experienced bond defaults as credit conditions tightened, but it will help lead the sector into a more sustainable development mode in the longer term.

After all, property prices will not go up forever, especially given slower urbanization and people's growing need for affordable housing. The quicker developers rid themselves of improvident lending, the better they can fit into the future industry landscape of slower, higher quality growth.

"The recent debt events at some real estate developers should not undermine the authorities' efforts to strengthen the long-term financial conditions of the sector as a whole," stated a report from the ASEAN+3 Macroeconomic Research Office, a regional economic surveillance organization.

Developers having a lower debt burden and better ability to repay loans will also mean a lower risk of bad loans for banks and bond defaults for investors, strengthening overall financial stability.

Furthermore, moves to deleverage the real estate sector have helped to reduce the debt level of the whole economy, leaving more policy room for countering any potential economic shocks in the future, especially given the prolonged uncertainties presented by the COVID-19 pandemic.

With slowing growth in property development loans and mortgages, China's macro leverage ratio, or the debt-to-GDP ratio, decreased by 5.3 percentage points from the beginning of the year to 264.8 percent by the end of September, according to the National Institution for Finance& Development, a think tank.

The leftover policy room may be tapped in the coming year, as inflated energy and commodity costs, sporadic COVID-19 cases and a slowing property market may continue to weigh on the economy.

Still, experts note that it will be critical for the government to properly adjust the strength of deleveraging moves in the near term to avoid any widespread liquidity risks for developers that could result from overly tight credit conditions.