Housing is China’s weak spot
by Yang Yao,
2014-06-25 06:54:43.0
CHINA’s property sector has been a source of serious concern for several years, with soaring prices raising fears of overheating in the housing market. But with price growth easing, it seems the government campaign to rein in property risk is finally taking hold. The danger now is the housing market may collapse, bringing China’s economic prospects down with it.
In its effort to control rising housing prices, the government has pursued nine distinct policies, not all of which have served their purpose. Though limits on mortgages for first-time buyers and minimum residence requirements for purchasing property in a first-tier city such as Beijing or Shanghai helped to ease demand, supply-side tactics, such as limiting credit to property developers and imposing new taxes on property sales, have proved to be counterproductive.
This flawed approach allowed China’s housing prices to continue to rise steadily, fuelling housing bubbles, especially in first-tier cities. The average Beijing resident would have to save all of his or her income for 34 years before being able to purchase an apartment outright. In Shanghai and Guangzhou, the equivalent is 29 and 27 years, respectively — much higher than in other world cities.
The expectation that this trend will continue has driven home owners to retain possession of their properties, even though rental rates amount to less than 2% of a property’s market value. But, with the real-estate sector finally facing a downturn, the time to rethink this investment strategy has arrived.
In the first four months of this year, housing sales dropped nearly 7% year on year, with construction of new floor area falling more than 22%. As a result, downward pressure on prices is mounting.
In normal times, citizens and officials alike would welcome this trend. But, at a time of weakening economic performance, China cannot afford an implosion of the real estate sector, which accounts for at least 30% of overall growth.
Though China’s government has expressed its willingness to sacrifice some growth in its pursuit of structural reform and rebalancing, the effect of a housing-market collapse on the financial sector would cause growth to slow beyond the acceptable limit.
That impact partly reflects the highly problematic nature of the government’s long-awaited move to liberalise interest rates. Instead of taking a direct approach — lifting the interest-rate cap imposed on banks — liberalisation has been achieved by allowing shadow banking to flourish. As a result, a large number of nonbank financial institutions such as wealth management companies and online financial services providers are now using promises of high returns to attract small investors. Making matters worse, the monetary authorities have tightened the credit supply, in an effort to deleverage the economy.
While both interest rate liberalisation and deleveraging are critical to the long-term health of China’s economy, the skyrocketing cost of borrowing is forcing many low-risk companies, which are unable to offer sufficiently high rates of return, out of the market.
At the same time, property developers who have borrowed heavily from shadow-banking institutions, on the assumption that property prices will continue to rise steadily, may struggle to repay their debts, with a sharp decline in prices inevitably leading to defaults.
Given that the formal banking sector provides a large share of shadow-banking finance, this could initiate a chain reaction affecting the entire financial sector.
Many remain convinced that the government, which holds the world’s largest foreign exchange reserves and wields virtually unchecked authority, would be able to prevent a financial crisis. But the financial crisis in the fast-growing city of Wenzhou, triggered by bad loans, suggests otherwise — not least because the economy has yet to recover fully. There is no reason to believe a similar crisis could not occur nationwide.
To avoid such an outcome, China’s leaders should urgently adopt countercyclical measures. They should begin by eliminating non-market-based restrictions on the real-estate sector, which have generated serious distortions not only in the economy but also in people’s lives, with some couples divorcing temporarily to gain the right to purchase an additional apartment.
When it comes to the real estate sector, China’s government has consistently had the right objective and the wrong strategy. It is time to align intention with action. Otherwise, China’s financial sector — its entire economy — will suffer.
• Yang Yao is director of the China Centre for Economic Research at Peking University.
© Project Syndicate 2014
A couple on a scooter ride past construction projects and completed apartment buildings in Haikou, Hainan province, China. Picture: BLOOMBERG
CHINA’s property sector has been a source of serious concern for several years, with soaring prices raising fears of overheating in the housing market. But with price growth easing, it seems the government campaign to rein in property risk is finally taking hold. The danger now is the housing market may collapse, bringing China’s economic prospects down with it.
In its effort to control rising housing prices, the government has pursued nine distinct policies, not all of which have served their purpose. Though limits on mortgages for first-time buyers and minimum residence requirements for purchasing property in a first-tier city such as Beijing or Shanghai helped to ease demand, supply-side tactics, such as limiting credit to property developers and imposing new taxes on property sales, have proved to be counterproductive.
This flawed approach allowed China’s housing prices to continue to rise steadily, fuelling housing bubbles, especially in first-tier cities. The average Beijing resident would have to save all of his or her income for 34 years before being able to purchase an apartment outright. In Shanghai and Guangzhou, the equivalent is 29 and 27 years, respectively — much higher than in other world cities.
The expectation that this trend will continue has driven home owners to retain possession of their properties, even though rental rates amount to less than 2% of a property’s market value. But, with the real-estate sector finally facing a downturn, the time to rethink this investment strategy has arrived.
In the first four months of this year, housing sales dropped nearly 7% year on year, with construction of new floor area falling more than 22%. As a result, downward pressure on prices is mounting.
In normal times, citizens and officials alike would welcome this trend. But, at a time of weakening economic performance, China cannot afford an implosion of the real estate sector, which accounts for at least 30% of overall growth.
Though China’s government has expressed its willingness to sacrifice some growth in its pursuit of structural reform and rebalancing, the effect of a housing-market collapse on the financial sector would cause growth to slow beyond the acceptable limit.
That impact partly reflects the highly problematic nature of the government’s long-awaited move to liberalise interest rates. Instead of taking a direct approach — lifting the interest-rate cap imposed on banks — liberalisation has been achieved by allowing shadow banking to flourish. As a result, a large number of nonbank financial institutions such as wealth management companies and online financial services providers are now using promises of high returns to attract small investors. Making matters worse, the monetary authorities have tightened the credit supply, in an effort to deleverage the economy.
While both interest rate liberalisation and deleveraging are critical to the long-term health of China’s economy, the skyrocketing cost of borrowing is forcing many low-risk companies, which are unable to offer sufficiently high rates of return, out of the market.
At the same time, property developers who have borrowed heavily from shadow-banking institutions, on the assumption that property prices will continue to rise steadily, may struggle to repay their debts, with a sharp decline in prices inevitably leading to defaults.
Given that the formal banking sector provides a large share of shadow-banking finance, this could initiate a chain reaction affecting the entire financial sector.
Many remain convinced that the government, which holds the world’s largest foreign exchange reserves and wields virtually unchecked authority, would be able to prevent a financial crisis. But the financial crisis in the fast-growing city of Wenzhou, triggered by bad loans, suggests otherwise — not least because the economy has yet to recover fully. There is no reason to believe a similar crisis could not occur nationwide.
To avoid such an outcome, China’s leaders should urgently adopt countercyclical measures. They should begin by eliminating non-market-based restrictions on the real-estate sector, which have generated serious distortions not only in the economy but also in people’s lives, with some couples divorcing temporarily to gain the right to purchase an additional apartment.
When it comes to the real estate sector, China’s government has consistently had the right objective and the wrong strategy. It is time to align intention with action. Otherwise, China’s financial sector — its entire economy — will suffer.
• Yang Yao is director of the China Centre for Economic Research at Peking University.
© Project Syndicate 2014
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