Since COVID, global construction companies have become increasingly concerned about higher interest rates and lending limitation programs, which haveresulted in project funding difficulties. Plus, higher interest rates drive up the costs of transportation, labor, and building materials such as steel, lumber, concrete, etc. Additionally, unpredictable fiscal and monetary environments impact buyer confidence, slow demand, and lower purchasing power.Interest rate instabilityand funding constraints for developers and investorscan substantially damage an economy, as for many countries, the construction industry accounts for a significant share of GDP.
Over the last decade, China’s real estate sector has been considered the economy’s main driver. A significant part of its success relied on the high leverage used by developers and investors. In 2020, the government introduced debt limitations to lower thefinancial system’s exposure to the sector’s risks. This resulted in defaults by many developers as they stopped completing presold real estate projectsand investors cancelled their payments.
Weakness in the country’s real estate sector continued into 2024 and impacted many other parts of the economy. In May of this year, the Chinese government made itsfirst attempt to revive the country’s property market. It offered regional governments to support thepurchase of unsold properties. However, due to unattractive terms, only asmall fraction of local governments chose to access this program.
At the end of this past September, to secure 2024’s economic growth target of +5.0%, the . The 30-basis-point reduction was the largest since 2016. China’s Finance Minister, Lan Fo’an, has indicated more government borrowing may be on the horizon. With these new incentives, local governments have been allowed to use special bonds to finance thepurchase of unsold homes.
Impact on Global Interest Rates and Construction
The slowdown in theChinese economy caused by the deceleration of real estate activityhas impacted global markets in several ways. Demand for steel, copper, and cement, used in construction projects worldwide, has been reduced dramatically. As prices for these materials have softened, globalmining and manufacturing industries have experienced aslowdown. This has reduced economic activity in the countries heavily reliant on exports to China, particularly Australia and Africa, where the mining sectors plays inordinately large roles.
Slow domestic consumption in China has also impacted European manufacturing. For example, for the first time ever. Other companies in Germany have indicated they are planning cutbacks, and theservice sector has not been able to fully compensate for the reduction in goods output.
Even thoughunemployment rates remain at record low levels in much of Europe, the European Central Bank (ECB) recently decided to implement another reduction in borrowing costs. According to projections made by economists at Goldman Sachs, there are likely to be interest rate cuts at every ECB meeting until the deposit rate drops from 3.50%to 2.00%.
What’s next?
China’s economic slowdown requires the government’s immediate attention. Stimulus to the economy will create a tailwind for the domestic construction and real estate sectors. The good news is that as the country’s Finance Minister Lan Fo’an has said, “The central government still has quite large room to borrow and increase the deficit.” The available financial instruments include special bonds to finance the purchase of unsold homes, issuing more sovereign bonds, and budget revisions directed at easing the debt burden carried by local governments.
In Europe, the high borrowing costs resulting from the several-years run-up in interest rates have slowed the development of commercial real estate and infrastructure projects across the continent. If the ECB proceeds with further cuts, it could provide much-needed relief to developers, allowing them to secure the funding necessary to move forward with new projects.
Conclusion
The impact of China’s real estate market collapse has been felt in various industries worldwide. As central banks globally respond with interest rate cuts, the construction industry will find relief from financial pressures. The road to recovery will still be complicated. Ultimately, a healthy combination of more relaxed interest rates, constrained inflation, and closer-to-normal unemployment rates will determine the pace of recovery for construction everywhere.
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