A Love-Hate Relationship: Why Guangdong’s Financial Health Is So Tied to Property

Jun 20, 2014

A Love-Hate Relationship: Why Guangdong’s Financial Health Is So Tied to Property

China’s southern province of Guangdong was the first beneficiary of Beijing’s policy of opening up the economy to the outside world, becoming an export powerhouse and a magnet for foreign investment. It was also among the first local governments given a chance to issue bonds on its own – without Beijing holding its hand – as part of the central government’s plan to expand the financing channels of better-managed provinces and cities.

But a credit rating report on Guangdong shows that even this relatively well-to-do province is heavily dependent on land and property sales, and that could make it vulnerable to financial stress in the current real-estate market downturn.

The credit report, issued by Shanghai Brilliance Credit Rating & Investors Service Co., was released publicly on Tuesday thanks to the requirement that local governments need to make their financial position transparent before they can sell bonds. The financial data show that in 2012 – the most recent year for which full figures are available – more than half of the province’s revenue came from land sales. Moreover, that relatively high dependence was actually below the national average.

Most local governments still rely on the central government to issue debt on their behalf. But Guangdong is one of the privileged few that can issue bonds directly, and it plans to sell 14.8 billion yuan ($2.4 billion) worth of debt this year.

Shanghai Briliance gave Guangdong an overall rating of AAA, the highest level possible, reflecting what it said was the province’s stable economic and fiscal conditions.

Guangdong has become a center of light industry, has a healthy service sector and boasts relatively high incomes. That gives it a comparatively diversified income stream – at least compared to other parts of the country.

But there are plenty of concerns of potential repayment problems, as Shanghai Brilliance made clear. The provincial government is still dependent on land sales for income and it has made heavy investments in property as the real-estate market is heading south.

In good times, a red-hot property market has boosted the provincial government’s income and enabled higher spending levels, the rating firm said.

In 2013, when home sales were up 40%, Guangdong’s government revenue surged 62% over the previous year while spending climbed 55%, the rating firm said. About 35% of the province’s fixed-asset investment went to the property market in 2013, compared with 27% in the manufacturing sector.

That compares with real-estate taking 25% of total fixed-asset investment for all of China last year, according to J.P. Morgan economist Zhu Haibin.

With the property market cooling as a result of increased supply and weaker demand amid an economic slowdown, the provincial government could see trouble down the road.

“Guangzhou’s economic growth has a definite reliance on the property market,” the rating company said. “Fluctuations in the property and land markets will affect government income.”

The average price of new homes in 70 Chinese cities declined in May from April, the first such drop in two years, as property developers cut prices to offset sluggish demand and a supply glut.

Like the rest of the country, the province’s property market is struggling this year. Average new home prices in Guangzhou, the provincial capital, were unchanged in May from April, but for Shenzhen, China’s manufacturing hub, prices were down 0.2% month-on-month.

Thanks to the bond sales, investors are getting a peek at local-level financial records, which normally would be hidden from the public.

It’s hard to say whether the investing public will snap up the Guangdong bonds — or shy away due to worries over the province’s ability to repay. But the credit report makes clear that the health of the property sector is closely tied to the health of Guangdong’s finances. And if one of the better managed provinces is facing repayment risk – the risk for other areas is certainly even greater.