Analysis on the Chinese Property Market

8/8/2019 Analysis on the Chinese Property Market

http://slidepdf.com/reader/full/analysis-on-the-chinese-property-market 1/8

Analysis on the ChineseProperty Market

China"s massive fiscal and monetary stimulus to rebuffthe effects of the global downturn with ramped updomestic demand stoked a property bubble, drawingcomparisons to the Japan and US housing bubble. Thereal estate market is now vulnerable to interest ratehikes, though it should not spark a meltdown as it did inJapan in the early 1990s. Nevertheless further pricegrowth is certain, which raises risks of social tensionand economic instability.

OM Jung-Myung

Analysis on the Chinese Property MarketOM Jung-Myung

China's massive fiscal and monetary stimulus to rebuff the effects ofthe global downturn with ramped up domestic demandstoked a property bubble, drawing comparisons to the Japan and UShousing bubble. The real estate market is now vulnerable to interestrate hikes, though it should not spark a meltdown as it did in Japan

in the early 1990s. Nevertheless further price growth is certain,which raises risks of social tensionand economic instability.

Investment Sputs a Rebound

When the global financial crisis erupted, the Chinese government respondedquickly with economic stimulus measures. Thanks to its effective response, theeconomy rapidly recovered from a trough that spanned the fourth quarter of 2008

and the first quarter of 2009, posting annual growth of 8.7 percent in 2009. Therebound was attributable to increased domestic demand on the back of thestimulus, as recession in advanced countries made it impossible for exports to leadthe way out of China's slump.

The stimulus action included strong fiscal and monetary expansion. Although thefiscal deficit did not balloon to high levels compared to GDP, the amount of bankloans and money supplies did surge to historically unprecedented levels.

The main reason for this was that state-owned enterprises (SOE) and localgovernments took loans from state-run banks and rapidly invested the funds. In

2009, total new loans amounted to 9.6 trillion yuan, almost double the 4.9 trillionyuan of 2008. Among these, loans to local governments for investment in



infrastructure and facilities1 were 3 trillion yuan, while those to SOEs were 3.5trillion yuan. Accordingly, about 70 percent of the loans were aimed at investmentfor economic stimulus, which served as a growth engine in 2009. Indeed,investment, or gross capital formation, was the dominant driver of the economy,

which contributed 8.23 percentage points to economic growth. Moreover,consumption promoted by the stimulus, such as plans to provide energy-efficient,environment-friendly home appliances and cars at cheap prices to rural residents,contributed 4.62 percentage points to growth. Drastic declines in exports on theother hand, contributed negative 4.15 percentage points of growth.

Adverse Effects of the Rapid Rebound

Negative effects of the record loans and monetary expansion first appeared in theproperty market. After a brief time lag, consumer prices started increasing. Realestate is an important investment in China, where the financial market is notadvanced, and where only a small selection of products with limited gradations inrisk are available. Hence real estate investors have grown despite the globalfinancial crisis and uncertainties in the future. From June 2009 property pricegrowth has continuously reached new highs. Though the rate slowed this year,prices remain high. Concerns of a bubble began to grow in the second half of 2009,

and further escalated in November 2009 when Dubai asked for a moratorium on itsdebt. The worries were mostly about the rapid increase in new loans, which sentproperty prices skyward, creating an asset price bubble. China's bubble was evenlabeled "Dubai times 1,000–or worse."3

In a somewhat muted and passive response, the Chinese government tightenedmonetary policy, increasing issuance of monetary stabilization bonds in the secondhalf of 2009, while limiting the aggregate number of eligible loans. To stabilizeproperty prices, the government has focused on discouraging speculation, raisingthe minimum payment for the second installment in a home purchase.4 Thegovernment also limited loans and forced higher interest rates on homeownersbuying a second home. As a result, the growth rate of property prices turned



downward in 2010. Nevertheless, property prices are still high compared to the past.

Despite the moderate cooling of the property market, the consumer price index(CPI) has maintained its upward momentum, surpassing 3 percent growth year-on-

year in May

5

this year and reaching 3.3 percent in July. As changes in CPI lag M1growth by two to three quarters in China, consumer prices are likely to rise furtherin the future. Some warn that with consumer prices steadily rising, higher interestrates will follow, and this will burst the real estate bubble just as it did in Japan inthe early 1990s.

Indeed, the formation of China's property bubble can appear much like that of Japanin the 1980s. The similarities include: 1) a massive current account surplus fueledby a high savings rate and undervalued currency; 2) monetary expansion sparkedby increased foreign exchange reserves; and 3) falling real interest rates under aloose monetary policy that encourage investors to borrow and invest aggressively

in real estate. Some Chinese media have reported that China is undergoing thefourth phase of a bubble collapse that is taking the same course as Japan's.6 SinceChina has led global economic growth since the financial crisis, careful monitoringfor a possible collapse is all the more important.



Possibilities of a bubble Collapse in the Chinese Property Market

Japan and the US present good examples of a property market meltdown and theyboth exhibited common symptoms before the plunge. First, household debt wasextremely high. US household debt amounted to 133 percent of disposable incomein 2007 right before the crisis, while debt in Japan was 130 percent in 1990. Second,

the increase in real estate prices had been running ahead of growth in disposableincome from 1999 to 2006 in the US and from 1986 to 1991 in Japan. Both countriesmaintained low interest rates before their property bubble burst, spurring a sharprun up in home prices with deeply leveraged purchases; loan growth remained farhigher than income growth for at least five years.

China's price to income ratio (PIR) is among the highest in the world, and accordingto some analysts, the market is frothy because housing prices are very high interms of income levels. In fact, China's PIR is eight times on average, 19 times inBeijing and 16 times in Shanghai. This is very high compared to other countries:three to six times income in the US, 7.5 times income in Korea and 5.7 times income

in Japan.



Despite such high prices, 70 percent of residents in large cities and 80 percent ofthose in ordinary cities have their own house. This is because many homeownersown homes provided by the government until the housing policy reform of 1998.Most significantly, China's household debt is only 39 percent of disposable income;

accordingly Chinese property owners can withstand a decrease in property prices,as they are not suff ering from high interest rates.7 In addition, the rate of increasein real estate prices surpassed disposable income growth only in the second half of2009, meaning that if there is a bubble in the market, it is less than a year old.

Therefore, real estate prices are high in nominal terms, but are not in practice, anactual burden for most people. Considering the household debt ratio, the time thebubble was formed, and the rate of home ownership, if property prices slide, it ismore likely to be a temporary adjustment and correction, rather than a warning signof a coming meltdown.

Low Financial Industry Exposure to the property Market

New loans for property increased 327 percent in a year from 480 billion yuan in 2008to 2 trillion yuan in 2009, and recorded 47 percent growth in the first half of 2010

compared to the same period of 2009. However, in 2010, the share of loans forproperty has remained a low 20 percent of the total, compared to 33 percent inKorea (March 2010) and 39.2 percent in the UK in 2006 (immediately before thecollapse of its own housing bubble). As of the second quarter of 2010, loans forproperty (real estate development and mortgages) amounted to 20 percent of thetotal even after property prices soared from the second half of 2009.

Also, Chinese banks appear financially sound. Loans increased remarkably in 2009as a result of government stimulus, but the loan-to-deposit ratio stood at 70 percentin April 2010, thanks to the government's 75 percent cap. Compared to bank assets,loans accounted for only a small amount,8 while property-related loans took only 10

percent of assets, enough for banks to cushion themselves from a plunge in real



estate prices.9 Therefore, it is highly unlikely that a property market crash in Chinawould trigger a series of bankruptcies among financial institutions, precipitating afinancial crisis, as it did in the US and Europe in 2007 and 2008.

Long-Term Challenges of the Chinese Property Market

Chinese property issues are directly linked to government revenue. Real estatesales increasingly account for a greater share of local government revenue. Salesaccounted for 23 percent in 2009.10 This has prompted many analysts to predict thatthe government would not control property prices, as price increases mean higherpublic revenue. To maintain stable financial income, reasonable growth of realestate prices would be ideal.

Meanwhile, most current homeowners benefited from the government housingpolicy. Today's new arrivals to cities, self-employed people, and new graduates,however, will find it hard to buy their home. Some non-owners even refer tothemselves as "house slaves," working only to save enough to buy a home.

Property issues represent not only economic, but also social, class, generation, andurban-rural disparities. Although a bursting property bubble is improbable,continued price growth may spark severe economic and social problems. Toprevent this, the government should maintain balance between housing pricecontrol and government revenue.

Currently, China is facing economic and social changes resulting from a transition



in its growth commodel.11 As the property sector takes a large share in theeconomy, China needs to come up with solutions to prevent property prices fromundermining economic and social stability, particularly in this transitional period.

KeywordsChinese property market, housing loans, GDP growth, bubble collapse, disposableincome, household debt

Note

1. Chinese local governments are entitled to issue bonds but have hardly issued any since the financial crisis, because the central government has strictly controlled issuance.

2. Liu Mingkang (May 2010), China Banking Regulatory Commission (CBRC).

3. James Chanos, President of Kynikos Associates.

4.Home purchases typically involve three installments. The first payment is at the contract signing. The second and third payments are at preset times that are negotiated beforehand.

5. Premier Wen Jiabao announced his goal to suppress CPI of 2010 to 3 percent or less in the National People's Congress in March.

6. The first phase is currency appreciation after the introduction of the currency basket system in 2005 in China and the Plaza Accord in 1985 in Japan. The second phase is a surge in real estate investment, as witnessed in 1986 in Japan and in 2006 in China. The third phase is economic stimulus plans introduced in 2008 in China and in 1988 in Japan. The fourth phase is a bursting of the property bubble induced by a rate increase, which started in 1991 in Japan, but has not appeared in China yet.

7. Exceptions are large cities, including Beijing and Shanghai, where the rate is higher than the average, resulting in potentially bigger price adjustments.

8. Loans accounted for 51 percent of bank assets, and the Capital Adequacy Ratio as of June 2010 was 11.1 percent.

9. As for Korea, the loan-to-deposit ratio was 106 percent in March 2010, which could climb to 117 percent when CD rates were not considered.

10. CEIC, 2009 Local Government Budget Implementation, 2010 Plans for the Local Government Budget.

11. Hu Jintao and Wen Jiabao announced a transition in China's growth model so

that domestic consumption, rather than exports, can drive economic growth.



Documents

Analysis on the Chinese Property Market