Cracks In China’s Construction Bubble (But It’s Not Going To End)

China’s phenomenal construction bubble, driven by local governments that must keep their economies growing, no matter what the costs, and funded largely by state-owned megabanks, has led to an equally phenomenal misallocation of capital, overbuilding, waste, ghost cities, empty shopping malls, and recently: an epidemic of shuttered luxury department stores.

The ghost cities and dead malls have been documented in riveting photos or videos, such as CBS’s 60 Minutes. “If the bubbles are not controlled, the result will be catastrophic,” Wang Shi, chairman of China Vanke, the largest residential property developer, had warned a while back.

They aren’t “controlled.” And some are already popping. In retail land, for example.

Overall retail sales remain strong. In July, they rose 13.2% year over year. Online retail sales jumped 67.5% in 2012, accounting for 6% of total retail sales. They pressure brick-and-mortar retailers, particularly department stores. One of the culprits: apparel. The department store staple has become a very popular item for online retailers. Department stores as a whole booked average sales growth of 16.5% in the period of 2006-2011, but in 2012, sales rose “only” 8.9%.

Yet, they continued to sprout like mushrooms, often side by side, with exactly the same products on their shelves, a homogenized bunch, with nothing else to fight over than price. Hence ferocious price wars. Shopping malls, which are also sprouting like mushrooms, are syphoning off customers. Department stores have few defenses in this shifting retail environment. Most of them are a new, or relatively new, and have not yet been able to create a loyal customer base.

At the same time, costs are soaring. Wages, utilities, everything. Rents for large outlets jumped 21% in 2012 nationwide, according to the Commerce Ministry.

Consequences? In Shenyang, a city of 8 million people in northeast China, the Chinese department store chain New-Mart closed a store on August 1, a couple of month after next-door neighbor, the Japanese department store Isetan, had shuttered its doors, the Asahi Shimbun reported. There are about 10 department stores in that area of town. In the city overall, floor space of department stores, including those under construction, has now reached 4 million square meters – more than four times the floor space of large department stores in shopping megalopolis Tokyo. Department stores have also shut down in Beijing, Shanghai, Chengdu (a major store closed in July after its rent had quintupled!), and other cities.

Nevertheless, economic growth, which is petering out, must be maintained, no matter what the costs, and construction projects are simply the easiest way to accomplish that. But a big publicly announced stimulus package from the central government is not in the cards. Officials have bent over backwards recently to make that clear. The monstrous 4 trillion yuan package in 2008 has taken a lot of flak, including from government insiders, for having been ineffective. And there is no appetite for more of the same.

But “government and banking industry sources familiar with the situation” who “declined to be named due to the highly sensitive nature of the matter,” have been spilling the beans to the South China Morning Post. The central government, they said, is considering an “unofficial economic stimulus” to prop up key economies like Shanghai. On the quiet!

For that purpose, Agricultural Bank of China, one of the state-owned megabanks, inked a deal to lend the city of Shanghai 250 billion yuan (about $41 billion) for a number of big construction projects, the sources said. The loan would amount to 12.5% of Shanghai’s 2012 GDP. And it would be in addition to a massive loan from a state-owned bank to Shanghai to build a Hong Kong-style free-trade zone.

“Agbank confirmed to the Post that it had signed an ‘all-aspect strategic co-operation’ agreement with Shanghai, but declined to elaborate,” the paper reported. And the beleaguered stock market in Shanghai jubilated, rising a euphoric 2.4%, in anticipation of the state manna coming its way.

Other state banks are likely to jump into the fray to prop up the economies of other key area, such as Guangdong province whose export sector is teetering due to swooning worldwide demand for increasingly expensive Chinese goods. Even in China, according to the SCMP, such huge loan deals by state-owned banks for cities “are considered rare.”

So the central government is showing its hand. The property and infrastructure bubbles will continue to be nurtured by limitless borrowed money from state-owned banks, and these bubbles are still swelling up beautifully, whether or not the projects are needed, and whether or not ghost cities decay and department stores close their doors, and whether or not these loans can ever be repaid.

But the hot air is hissing out of manufacturing – despite all government contortions to the contrary. Now Zhang Ruimin, CEO of China’s largest appliance maker Haier Group, put his finger on the problem. And it doesn’t look good. Read…. Even the CEO Of China’s Largest Appliance Manufacturer Is Getting Cold Feet

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