8/9/2019 A Real Estate Bubble in China

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A REAL ESTATE BUBBLE IN CHINA?

Real estate prices of commercial and residential properties in China’s 70largest cities rose by 10.7% in February 2010, year over year, after 9.5%in January. Some estimates put the rise in average prices over one year at22%.

 Origins of this spectacular increase

It is directly linked to the measures of economic stimulation taken byCentral Government:

- to keep economy going, government injected Yuan 4 trillion since2008(14% of GDP).

- in June 2009, money supply(M2) surged to 28.5%, year over year,up from 15% at the beginning of the year.

- new loans to banks rose 34.5% year over year last June from 30.6%in May.

Resulting flood of money flowed into stocks, property markets, commodityinventories and consumer durables.Leveraged debt fuelling speculation came from local governments, whichhave borrowed trillions of dollars from the banking system to develop realestate projects. Incentives to local governments are targets fixed by

central authorities, as their performance is measured by GDP and fiscalrevenue, which can be boosted by real estate development. And a mainrevenue source for local and regional authorities is land sales todevelopers.

Consequence was an extraordinary housing bubble:-in November 2009, housing prices in 70 major cities rose 5.7%, fromprevious month, and housing starts nationwide rose 194%, year over year.-in Beijing residential district, homes sell for an average of almost $300per square foot, and a typical 1,000 square foot apartment costs about80x the average annual income of the city residents.

Effects of this bubble

It had positive effects on global economy, as it allowed GDP growth toreach a target of 8% in 2009.Construction, steel, cement, furniture are directly tied to real estategrowth (in November, retail sales of furniture and construction materials jumped more than 40%).

However, as capital is channelled into real estate, this hurts the country

long term prospects, by diverting capital from more productive uses. It

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decreases capital efficiency and contributes to lower domesticconsumption, which is already at a relatively low level.It threatens the nation financial stability by increasing debt levels andrelying on overvalued land as collateral.Real estate speculation increases social inequality, and prevents low or

middle income people to buy homes.

It could result in a significant rise of non performing loans. China’s bankslent a net total of $1.4 trillion in 2009, double 2008 volume. Much of theconcern relates o indirect borrowing by local governments. Barred fromborrowing directly from banks, local governments (cities, counties andprovinces) set up investment vehicles, to which the banks lent. Theseloans helped finance a wave of public constructions last year. Finances of local governments were already weak. This indirect borrowing raises therisks of rising bad loans if governments can’t find the cash to repay theseloans. Amount of debt accumulated by local governments could be aslarge as $1.6 trillion. This could be at the origin of a sharp rise in the ratio of banks nonperforming loans, which at the end of 2009 was 1.6%.

Measures taken to deflate this bubble

In November 2009, rules were announced to reign in developers:-minimum down payment of 50% on land payments against 20% to 30%previously-developers were required to completely pay off land purchases from

governments within 1 year of a sale agreement.-local governments were forbidden to give discounts to developers or toallow them to delay payments.

In December, Central government decided to impose a sales tax on homessold within 2 years of their purchase instead of 5 years to control overspeculation on short selling of urban homes.

Instructions were given to local governments to set aside at least 70% of local land supply for construction of small residential and state subsidizedunits.

People Bank of China said it will gradually normalize monetary conditionsthis year, with a 50% reduction of new loans extended by banks since thebeginning of 2010. It will also seek to slow growth in broad money supply(M2) to around 17% this year from 28% in 2009.

Housing market started to cool after these measures:-sales of residential properties grew 37% in the first 2 months of this yearagainst growth rates of over 50% in 2009.-rise in national property prices fell slightly from 1.3%, month over month

in January 2010, to 0.9% in February, but property prices were still up 7%,

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year over year, last February and Chinese property sales rose 70%,yearover year, in the first 2 months of 2010.

Problem is that Central Government cannot take too restrictive measures

that would sharply reduce global economic growth. According to someestimates, a crash in real estate could reduce GDP growth to 2%, insteadof its 8% target, as Chinese export development is likely to be restrainedfor still some years. This is at the origin of a moral hazard, as speculatorsthink government will never let real estate value fall.