Saturday, March 13, 2010

It may look like a bubble, but it’s stronger

IS there or is there not a property bubble in China? That is the billion-dollar question that everybody is asking now. Before we attempt to answer that, it is instructive to examine what caused prices to race ahead in the last one year.

The obvious answer was the government’s four trillion yuan (S$816 billion) stimulus package introduced to support the economy in view of the collapse in exports. In his weekly market report recently, Tan Teng Boo of Capital Dynamics outlined how the stimulus package led to the rapid increase in property prices last year.

As part of the stimulus package, the central government ordered banks to turn on the tap to give loans freely. Last year, China’s financial institutions extended 9.59 trillion yuan in new credit. Of that, 1.4 trillion yuan went to individual housing loans and 576.4 billion yuan to housing development loans.

At the same time, the government was carrying out its stimulus programmes through the state-owned enterprises (SOEs). With slacking demand, many SOEs found themselves with excess capacities. Where to put the money that the government has injected? Since the property market has a reputation of generating quick and high returns, it became the natural choice for the SOEs to channel the extra money that they had received. Many SOEs established new business entities to venture into the lucrative property market. The participation of the SOEs with deep pockets into the property market initially sent land prices sky high. This subsequently led to elevated house prices.

Two, with the real economy slowing down significantly, some businesses decided to get out of their original business activities and instead used the profits that they had made in the past few years to invest in the property market. The switch gave further impetus to the property market. And three, in addition to the measures provided in the stimulus package to accelerate the construction of low-cost housing, the government also introduced other preferential policies in 2008-2009, directed specifically at the property sector. These included:

* Cutting the deed tax rate for first-time buyers of houses under 90 sq m from 3.5 per cent to one per cent;

* Exempting stamp duty on property purchases;

* Exempting land value-added tax on property sales;

* Cutting the minimum down payment for first-time home buyers to 20 per cent from 30 per cent;

* Cutting the interest rate for personal housing provident fund loans from 4.32 per cent to 4.05 per cent for five-year loans; for loans above five years, the reduction was from 4.86 per cent to 4.59 per cent;

* Cutting the interest rate on mortgages to 70 per cent of the benchmark lending rate;

* Reducing the ownership period eligible for tax exemption for sales of homes by individuals from five years to two years.

All the above measures drew in droves of buyers. Prices climbed. Then there was the hot money. China’s economy bottomed out in the first quarter of 2009.

According to Mr Tan, when it became apparent that economic activities have been successfully revived by the Chinese government’s aggressive expansionary policies, hot money began to flow in to take advantage of the opportunities presented by the fact that China’s economy would recover earlier and faster than the other economies. In 2009, China’s trade surplus fell US$99.4 billion from 2008, yet its foreign exchange reserves surged by US$453.1 billion to US$2.4 trillion. The strong inflow of hot money also played a role in pushing up property prices.

Meanwhile, there are compelling factors which ensure a strong and sustained domestic demand for property. First, the rapid rate of urbanisation. According to Lu Dadao, president of the Geographic Society of China, China took 22 years to increase its urbanisation rate from 17.9 per cent to 39.1 per cent. It took the UK 120 years, the United States 80 years and Japan more than 30 years to accomplish the same feat. With the relaxation of the household registration system, more and more people are moving to the cities, creating strong demand for urban housing.

Meanwhile, the psychological make-up of the Chinese, coupled with the lack of options in which to grow their nest eggs, make real estate an attractive place to park one’s money. Real estate is like the proverbial bar of gold. In a recent article, Time magazine interviewed a taxi driver in Shanghai who owns three apartments in the city. He hasn’t tried to rent out two of his three apartments, saying: ‘It’s not that important to gain income from them; there is security in just owning them. They are paid for, and I know that if I ever get into any kind of economic trouble, I can sell them. That’s real security.’

Real estate makes for a good hedge against inflation given the sharp expansion in money supply in 2009. That many are using their savings to pay for the apartment is supported by the statistics that China’s mortgage market constitutes only about 10 per cent of its gross domestic product. This compared with 48 per cent for Hong Kong. Keeping money in the bank yields only 2.25 per cent in a one-year fixed deposit.

Now, of course, the government is trying to reverse some of the policies. The question is, is it too late? For that, we need to answer how far ahead of fundamentals have property prices gone in China. In Japan, in the four years right before its property bubble went bust the average growth rate of residential land prices in the country’s six major cities was 25 per cent. China’s appreciation is nowhere near that.

And while the growth rate in US house prices in the 10 years before the sub-prime crisis broke out was not as strong as that of Japan’s, it was stronger and more sustained than that of China’s.

The worrying thing is, China’s prices are catching up fast. House prices in 70 large and medium-sized Chinese cities climbed 3.9 per cent in October last year. The pace of increase picked up to 5.7 per cent in November, and yet even higher to 7.8 per cent in December. In January this year, the number was a 9.5 per cent rise from one year earlier, the fastest growth in 19 months.

The government, it seems, will have to come up with harsher measures to cool things down. The consolation is, the consequences of a reversal in property prices would not inflict that great a pain in the Chinese economy given the lesser extent of credit being used in the market.

In China, personal savings and parental contribution are the two major sources of financing for home purchases. According to Patrick Chovanec, a professor at Beijing’s Tsinghua University who studies the Chinese real estate sector, only about 50 per cent of residential purchases are made using mortgages. The other half are paid for in full at the time of acquisition. (In the US, by contrast, over 90 per cent of residential housing transactions are financed with mortgages.) Wong Kok Hoi of APS Asset Management is of the view that if prices were to decline 20 per cent, a portion of the Chinese people’s substantial savings would be moved to the property market.

Even if prices were to decline by 30 per cent, the majority of home-owners would still not walk away from their mortgage obligations, as we saw in the US, because they still have positive equity in their homes, reckons Mr Wong. In that scenario, Shanghai-based banks would see their non-performing loans rise to 2 per cent and their profits impacted by 7 per cent.

All in all, it seems the bubble trouble in China is not as big as a lot of people fear it to be.

Source: Business Times, 13 Mar 2010

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