China’s real-es­tate wrongs

Financial Mirror (Cyprus) - - FRONT PAGE -

China’s real-es­tate sec­tor has been a source of se­ri­ous con­cern for sev­eral years, with soar­ing property prices rais­ing fears of over­heat­ing in the hous­ing mar­ket. But, with price growth eas­ing, it seems that the govern­ment’s cam­paign to rein in property risk is fi­nally tak­ing hold. The dan­ger now is that the hous­ing mar­ket will col­lapse – bring­ing China’s eco­nomic prospects down with it.

In its ef­fort to con­trol ris­ing hous­ing prices, China’s govern­ment has pur­sued nine dis­tinct poli­cies, not all of which have served their pur­pose. Though poli­cies like lim­its on mort­gages for first-time buy­ers and min­i­mum res­i­dency re­quire­ments for pur­chas­ing property in a first-tier city like Bei­jing or Shang­hai helped to ease de­mand, sup­ply-side tac­tics, such as lim­it­ing credit to real-es­tate de­vel­op­ers and im­pos­ing new taxes on property sales, have proved to be counter-pro­duc­tive.

This flawed ap­proach al­lowed China’s hous­ing prices to con­tinue to rise steadily, fuel­ing ma­jor 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 to be able to pur­chase an apart­ment out­right. In Shang­hai and Guangzhou, the equiv­a­lent is 29 and 27 years, re­spec­tively – much higher than in other ma­jor in­ter­na­tional cities.

The ex­pec­ta­tion that this trend will con­tinue has driven home­own­ers to re­tain pos­ses­sion of their prop­er­ties, even though rental rates amount to less than 2% of a property’s mar­ket value. But, with the realestate sec­tor fi­nally fac­ing a down­turn, the time to re­think this in­vest­ment strat­egy has ar­rived.

In the first four months of 2014, hous­ing sales dropped by nearly 7% year on year, with con­struc­tion of new floor area fall­ing by more than 22%. As a re­sult, down­ward pres­sure on property 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 realestate sec­tor, which ac­counts for at least 30% of over­all growth. In­deed, though China’s govern­ment has ex­pressed its will­ing­ness to sac­ri­fice some growth in its pur­suit of struc­tural re­form and re­bal­anc­ing, the im­pact 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 Chi­nese 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 Chi­nese 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, real-es­tate de­vel­op­ers who have bor­rowed heav­ily from shadow-bank­ing in­sti­tu­tions, based on the as­sump­tion that property prices would 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 China’s govern­ment – which wields with the world’s largest for­eign-ex­change re­serves and vir­tu­ally unchecked author­ity – would be able to pre­vent a ma­jor 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 that a sim­i­lar cri­sis could not oc­cur on a na­tional scale.

To avoid such an out­come, China’s lead­ers must ur­gently adopt counter-cycli­cal mea­sures. They should be­gin by elim­i­nat­ing non-mar­ket-based re­stric­tions on the realestate sec­tor, which have gen­er­ated se­ri­ous dis­tor­tions not only to the econ­omy, but also to people’s lives, with 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 – in­deed, its en­tire econ­omy – will suf­fer.

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