Faces of China

This translation was made for information purposes only. The views expressed in the article are that of the author and him alone.

Author: Xie Guozhong, independent economic expert.

Link to original essay: http://blog.caing.com/expert_article-171-2726.shtml

Translator’s note: Suggestions for further reading on the Chinese property market are included after the essay.

Nowhere to rest A translation by André Holthe

Are we able to avoid a new inflation in property prices?
　　
If we don’t commit to reform, then the central government’s regulatory policy will not have any big implications on the bubble in the property market.
　　
The central government has once again unveiled a new of set of regulatory measures to strengthen the supervision of the real estate industry. This time the government is significantly tightening mortgage loan policy. The first step is to cut down on the extent of favourable interest rates on mortgage loans for home buyers, the second being abolishment of favourable interest rates on mortgages, with a minimum first payment of 40% and finally letting banks decide mortgage interest rates, adjusting the scale of first payment to 60 %.
　　
The result is expected to be that the volume of both first-hand and second-hand housing will drop. However, in the market there’s no sign of panic. Why is that? Shouldn’t they be terrified when the government is announcing more regulations?.
　　
We’ve already seen this situation before, when the central government issued quite a few policies to prevent housing prices from rising too fast, but right after these measures started to show results, the central government relaxed its restrictions. The bottom line of market confidence is this: a large portion of local governments tax revenues are dependent on the property market, indirectly making the central government dependent on the property market. Consequently, the market don’t believe that the government really has the nerve to make a quick decision, cutting off its own source of income.
　　
There’s a big amount of circulating funds between local governments and real estate developers, and last years land and property sales resulted in a good profit. Thanks to the relaxed lending conditions following the economic stimulus package, they attained a large quantity of credit funds, which made both parties able to hold one’s ground despite a pressuring situation.

If everyone believe that the central governments policies will be relaxed quickly, then a drop in prices is meaningless. Today’s credit policies are almost blocking buyers who want to buy a second or third home out of the market. If you want to sell off the properties at hand, developers must hope for lower prices to attract first time home buyers. These are people with low incomes and without a lot of family capital. Stakeholders will not accept their new roles until the central government can make people believe that the present regulations are going to continue to drain out the funds of local governments and real estate developers.

But contrary to the intentions of the central government’s policies, local governments are already getting ready for a new rise in property prices. Local governments have for some time past been using bank loans to launch land requisition, dismantling structures and moving inhabitants. The range of increase in demolition compensation has been astonishing, because according to the present property prices, compensation for house demolition is already sufficient to purchase a new home. If property prices don’t continue to rise significantly, local governments will suffer losses due to this demolition, which is an unacceptable result.

This rehousing played an important role in maintaining last years property demand. A large portion of the home buyers were probably the same people who moved because of house demolition, using their compensation as first payment. After the sale of cheap state-owned houses to the public 10 years ago, compensation for house demolition has been the largest defray of expenses from the government to the people and at the same time the most important government contribution to today’s economic activity.

The positive effects of demolition compensation have also brought about important negative consequences. First of all, it has, as a matter of fact, increased social demand for policy levers. Local governments are borrowing money to pay for demolition compensation and land mortgages. Those who receive money for rehousing use this money as first payment of mortgage loans. In other words, it’s serving as a funds for mortgage loans, even though it’s money the government borrowed from the bank. From the banks perspective of financial management, this loan has no real security.

And second, although expensive demolition compensation has its benefits, however, it’s making local governments and the rise in property prices interrelated. Ultimately these expenses are undertaken by the emerging middle class. The last few years the central government’s policies have been beneficial for those with low incomes. Subsidizing minimum wages in cities and towns, land reforms in rural areas as well as setting commodity prices for everyday consumer goods all reflect a tendency. The house demolition system is also helping people with low incomes with new policies.

But the price, however, is paid by the middle class. The prices of their most important living expenses, namely housing, keeping a car and education for their children, have experienced rapid inflation. If policies are not adjusted accordingly, the pressure on the middle class will just continue to grow.

The Chinese property market is like a huge bubble. Average residents on the mainland have to spend 20 years of income to buy a home. This bubble is likely to continue because the liquidity of the Chinese banking system is still very much sufficient. This is partly due to global hot money flowing in, and partly originating from government policy levers that attracts capital to the market. But a bubble is still a bubble, accumulated over a long period of time, and the damage will be great to the national economy.

The stability of today’s society is depending on the middle class, because the middle class makes up a large number of people and if they are satisfied with their own situation, society will have a steady development. Policies that lead to high property prices is in fact a heavy taxation on the middle class and this will limit the growth of the middle class. China might develop into a society with the following structure: a few wealthy people, a lot of people without housing and a small middle class. This kind of society structure is unprofitable in the long term for a stable society.

Further reading

Uprofish’s China special on the property market.
Part 1
Part 2
Part 3
Part 4
Part 5
Part 6

“Developers on a Shopping Spree for Land” – Caing Online
“Deep Skepticism over Official Property Price Data” – Caing Online