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China’s property boom is ending, with important implications for the economy. A gradual slow-down would support Beijing’s goals for economic restructuring.
China’s property market is slowing, with construction starts and property sales falling rapidly over the first three months of 2014. This follows a decade of rapid growth, with the number of housing completions rising from around 5 million units in 2006 to around 11 million units in 2013.
0.3 The macroeconomic significance
China’s property market was once described by UBS investment bank as ‘the most important sector in the known universe’ due to its contribution to:
- Headline growth. Chinese growth is famously reliant on investment. Property investment alone accounts for around 10 percent of GDP. The investment bank Nomura recently forecast that, based on current policies, lower property investment will drag GDP growth to below 6 percent in 2014 (the target for 2014 growth is ‘around 7.5 percent’);
- Local government finances. Land sales provide nearly 50 percent of local government revenues. Lower prices mean less revenue, putting pressure on finding other sources of revenue (either more central government transfers, selling state assets, or raising new taxes);
- Related industries. The property sector provides crucial demand for a range of industries, some of which are already over-indebted and plagued by over-capacity (for example property developers, steel producers, cement producers); and, more tenuously,
- Consumption growth. Chinese households have much lower mortgage debt than their UK equivalents, so there is limited risk of widespread negative equity. However, a rapid fall in prices would reduce consumers’ perceived wealth, and therefore in theory their desire to buy things.
The top three issues’ dependency on the property sector is at the heart of China’s unbalanced growth model. So a gradual slowdown would support economic sustainability.
0.4 How large is the risk?
There is significant risk of a property crash in some areas. This is due to a mismatch in supply and demand, in particular too many high-end properties in the wrong parts of the country. This is illustrated by the ‘ghost towns’ like Ordos in Inner Mongolia. Such areas are dominated by speculative investors and prices are therefore vulnerable to a fall in confidence. However, a nationwide collapse in prices seems unlikely. On aggregate, China’s demand-side fundamentals for housing remain strong. Dragonomics, a Beijing-based consultancy, estimates demand at 10 million units of housing per year, fed by ongoing urbanization, the depreciation of existing urban housing stock, and the upgrading to larger properties by China’s middle classes.
0.5 Can the authorities control the situation?
So far, the authorities haven’t intervened forcibly. Beijing appears content to allow the market to adjust on its own, recognizing that short-term intervention may only make the situation harder to resolve in the future. For the most part the provinces are currently happy to toe the line.
However, this position could change quickly, for example if a major and well-connected developer was facing bankruptcy with wider economic implications.
The central authorities will be keen to ensure that any response is consistent with their long-term reform agenda. They will want to prevent a further build-up of over-capacity, either in terms of the wrong houses being built in the wrong places, or in terms of uncompetitive firms being kept afloat. There are two main ways they could deliver this:
- Housing demand can be stimulated by adjusting administrative measures that have been introduced in recent years to curtail price increases. These include limiting home purchases to local residents and requiring very high deposits, especially for 2nd homes. A couple of local governments have already adopted some of these measures; and
- Housing supply can be increased by expanding social housing. The central government announced earlier this year that they would build a further 100m units of social housing to accommodate rural migrants. The schedule for these completions can be adjusted to support a more gradual tapering down of property investment.
A further option would be to significantly loosen credit conditions, allowing banks to lend more money, including to troubled property developers. While this may provide short-term stability, it would compound China’s structural weaknesses. It would also represent a significant departure from the central government’s reform plans.
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