The cascading effect of the three red lines policy

The cascading effect of the three red lines policy

China’s economy is heavily dependent on the growth of the housing market. It is the third largest contributor to the national GDP, with some estimating the residential property market contributions at between 17% to 29%. The People’s Bank of China (PBOC) estimates that in 2020 direct investment in real estate was $1.8 trillion and contributed 7.4% to the GDP. In addition, the National Bureau of Statistics estimated that the construction industry, which is strongly predicated on the property market, contributed a further $1.15 trillion, which was 7.2% of the 2020 GDP. 

However, not only is the Chinese economy reliant on the real estate market, but individual households are too. The importance and prevalence of home ownership in China are two-fold. Culturally, it is perceived as a prerequisite for marriage, particularly for men. It is also a symbol of economic stability.  Consequently, China has the highest rate of home ownership in the world, at around 90%. Moreover, home ownership in China is an important marker of middle-class status, with the Chinese real estate market accounting for roughly 70% of Chinese personal wealth. Given the soaring property market prices, high resale value and the absence of property tax, many regard buying a second or third home as a wise financial investment. These factors have compounded, resulting in inflated residential housing prices.

To make matters worse, a lack of available housing, especially in large cities, has escalated housing prices even higher. Inversely, housing shortages are not a national phenomenon. In rural areas newly developed projects are sometimes left uninhabited as people migrate to the cities. 

The three red lines policy

Most Chinese home buyers purchase homes off plan from housing development projects, and developers then use this money to fund multiple housing projects simultaneously. These pre-sold homes account for between 70% to 80% of new home sales. Bank Group ANZ estimates that almost $220 billion worth of mortgage loans are tied up in developing projects. As a result, property development companies are some of the biggest drivers of the economy. According to NBS commercial housing sales grew from $914 billion in 2011 to $2.7 trillion in 2020 at an annual growth rate of 21.8%. 

The largest source of income for property developers comes from deposits and pre-sales of homes still under development. In 2020, developers raised over $1 trillion from these sources alone. Additionally, developers rely on credit to enable their projects, speculatively spending to complete their housing projects. In 2020 the property development sector borrowed more than $419 billion in domestic loans, accumulating over $5.2 trillion in  debt by June 2021. In response to mounting debt from property developers, the Chinese government introduced the three red lines policy in August 2020 to decrease lending.

The policy emerged from a symposium between the PBOC, the Ministry of Housing and Urban-Rural Development and China’s largest property developers, Evergrande Group, Vanke and Country Garden. The name of the policy refers to the three prerequisites for a company’s balance sheet;“ The asset to liability ratio must be greater than 70%, net debt to equity ratio must be less than 100%, and cash to short-term borrowings ratio must be less than one.” In addition, the government requires that all three project developers attain the stipulated debt reduction mandate by June next year. The three red lines policy aims “ to reduce leverage, increase liquidity, and mitigate financial risks associated with heavy debt refinancing strategies.”

Implementation of the policy has been detrimental to China’s property market. The debt reduction measures applied by the policy were the cause of property development company Evergrande Group defaulting on debt repayments, in turn halting construction on a number of their real estate projects. As a result, the balance sheets for project developers have continued to deteriorate. In 2020, property developers defaulted on $3.4 billion worth of bonds, shooting up to $7.1 billion, or 27% of all bond repayments, in 2021. In response, angry homebuyers are refusing to pay the mortgage on homes that are not completed.

The mortgage boycott

The Chinese nationwide mortgage boycott commenced in mid-July 2022 when a letter addressed to the Evergrande property developer group, which had made the most significant corporate default China has ever seen in December 2021, gained immense public attention. The letter was signed by 100 homeowners from the incomplete Dynasty Mansion project. The letter threatened that “All homebuyers with outstanding mortgage loans will stop paying” unless construction resumes before 20 October 2022. The letter quickly made its rounds on social media platforms such as Douyin and WeChat, garnering widespread support. Within four weeks, the letter became the boycott template for many other angry buyers of incomplete housing projects. Homeowners from over 320 projects in 100 Chinese cities have co-signed the boycott. 

The possible inability of project developers to deliver homes has shaken market confidence, triggering plummeting property values and sales. What this means for the broader Chinese economy remains to be seen.

What is Beijing doing about the crisis?

The complaints of protesters have spurred President Xi Jinping to order the completion of several housing projects across the country, with state-owned financial institutions being called to foot the bill. The three red lines policy has been eased, giving project developers more room to refinance their projects. The government has also committed to decreasing some lender liabilities and increasing their debt by 5%.

While many analysts believe that the measures taken by the government will inject finance into the market in the short term. However, it might not reverse the downward trajectory of the property sector. 

While the mortgage boycott appears to have had some success, China’s low tolerance for dissent has seen censors active on several social media platforms, scrubbing posts, silencing protesters and banning document-sharing links. Should the mortgage boycott become more than merely a social movement, it could be the seed of a much more contentious issue for the Chinese economy. 

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