China's heavy dependence on land sales and recent decline in land demands has led to pay cuts of employees

Lower Land Sales In China Could Lead To A Bigger Problem

by Sourav Datta - Dec 30, 2021 06:07 PM +05:30 IST
Lower Land Sales In China Could Lead To A Bigger ProblemXiamen, China (pixabay)
  • Chinese land sale revenues grew from 50 billion yuan to 8.4 trillion yuan in just two decades.

    The sudden restrictions on borrowing have had a domino effect on land sales as these companies do not have the requisite funds to take part in the land bank auctions anymore.

Provincial governments in China have been dependent on sales of land use rights to drive their finances. However, with lower demand for land from real estate developers, these Chinese provinces are looking at other ways to augment revenues.

Why are Land Sales Revenues so Important?

The dependence on land banks is evident from the fact that Chinese land sale revenues grew from 50 billion yuan to 8.4 trillion yuan in just two decades.

According to a report from Yuekai Securities, land bank sales accounted for anywhere between 90 to 120 per cent from provinces such as Jinagsu, Zheijang, Jiangxi, Hubei and several others. For Jiangsu, the revenue from land bank sales was upwards a $120 billion. Zhejiang saw similar numbers as well, followed by other provinces.

Another research says that land sales account for 40 per cent of the revenues for most provinces on average. Cumulatively, these land sales brought more than a trillion dollars for China’s provinces each year.

Lower Land Sales have Several Second Order Effects

The heavy dependence on land sales, and the recent decline in land sales has already led to pay cuts among the payments of employees. The total compensation is usually distributed between fixed and variable for employees.

So far employees have been paid the fixed portion in entirety, but the variable portion has seen cuts. Despite employees in provinces across China seeing 20-40 per cent pay cuts, there hasn’t been a huge backlash yet. People expect the economy to recover, and the payments to be restored to their original levels.

Until the economy recovers, it is likely that spending would be muted due to the pay cuts mentioned above. Consumption is a large part of China’s economy, contributing to somewhere around 55 per cent of the country’s gross domestic product (GDP).

With lower income, consumption is likely to decline, leading to slower growth. These provinces had raised debt to finance the investments in the past. But with revenues drying up, paying back the debt could be a difficult task for these governments.

Some provinces have resorted to closing down hiring programs as the governments cannot afford to pay salaries. Others are looking to find ways to increase revenues from other sources such as increasing taxes, implementing “bogus taxes”, and others.

Hegang, a province well-known for coal mining has put off plans to hire government staff at the lower levels, under a plan to restructure the city’s finances.

How did the Slump in the Housing Market Begin?

The slump in the housing sector began after the Chinese government took stock of the debt situation in the housing development companies. These companies had been on a building spree funded by easy debt and cheap labour for the last two decades.

The speculation in the residential housing market with easily available credit further aided the growth of these developers. The increasing importance of real estate developers finally led the Chinese government to implement the “Three Red Lines” in August 2020.

These were three basic rules about the finances of real estate developers – a 70 per cent ceiling on liabilities to assets, a 100 per cent cap on the net debt to equity ratio, and a minimum requirement of cash to short-term borrowings of one.

Based on developers breaching or meeting these guidelines, the decision on advancing more debt would be taken. Until these guidelines were implemented, lenders and investors could easily supply capital to developers.

But the decision to stop allowing heavy borrowing hit some lenders quite hard, Evergrande becoming the most well-known victim of the rules. As a result, Evergrande’s employees, creditors, suppliers, investors and other have been struggling with recovering their dues.

The sudden restrictions on borrowing have had a domino effect on land sales as these companies do not have the requisite funds to take part in the land bank auctions anymore. As a result, premiums paid during these auctions have lowered over time.

Even if developers do acquire a land bank, building real estate on it would be difficult in the absence of external funding. The government’s decision to impose restrictions on property speculation has resulted in a muted market for residential real estate as well.

Premiums on land banks had risen to around 19 per cent in 2019, but have since seen a slump. While 2021 started off on a good note, premiums have come down from 17 per cent in the second quarter to 8 per cent in the third quarter and 3 per cent in the fourth quarter of the year.

With the real estate sector contributing to 13 per cent of the country’s economy, employing millions, and forming a major part of the citizens’ net-worth, it remains a critical component of the economy.

For China, fostering growth while encouraging better lending quality could be a tough task. Realising the importance of the real estate sector, the government has begun relaxing rules to attract players in the real estate markets once again. However, so far, demand has not seen a significant increase.

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