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China Faces The Property Burst

As of this month technically and financially many property developers based in China have defaulted on the payments due on bonds. This was initiated some months ago when an internal circular called "Document 15" was received by banks to reduce working capital to local government financing vehicles (LGFV) that are half public half corporate-owned.

To understand the importance of real estate in China some facts need to be understood first. Most municipalities are having a large share of revenue coming via land sales to corporate or LGFV. This revenue leads to expenditure on other infrastructure within the cities. Thus, it makes a large chunk of the economy. From the other end investor point of view majority of their savings are blocked in real estate assets as the historic returns have favored them. But in current circumstances, developers have sold apartments at a thirty percent discount to create revenue resulting in backlash from these investors.

But as every economy does face its day of reckoning, it is time for China.

This is why the central bank has already reversed much of the tightening but it might be too late as much of the sector has been downgraded to default and many of those are in restructuring discussion that might have little success.

The problem with such a scale of default is that it will not be limited to China but would spread throughout the world as offshore bondholders take a large haircut or write off the full amount. Just for knowledge, these assets are said to be a total of $8.3 trillion in value, and most of them are off-balance sheets.

In the end, this will be painful but it might result in knocking down the inflation that has been the main worry of all, though only for a short time as there would be another tidal wave of stimulus waiting to be released.


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