At the IMF and World Bank meetings in Washington last week, the chief economist of the People’s Bank of China identified the country’s property sector, which accounts for 20 per cent of total investment, as the main downside risk for the Chinese economy.
Ma Jun, a former Deutsche Bank economist, told a panel that the real estate sector, state-owned enterprises and local governments were all over-leveraged and that exposure had been increasing at a rapid pace over the past few years. This rising level of leverage is the key reason for Beijing’s reluctance to open its wallet to prop up a rapidly-slowing economy.
Heightened fear about the Chinese property sector has galvanised analysts and commentators from the start of the year and opinions are polarised. Some are predicting a spectacular asset bubble burst similar to what occurred in Japan and the US, while others are retaining their faith in Beijing’s ability to manage the downturn.
Dr Li-Gang Liu, chief economist for Greater China at the ANZ, takes a close look at the debate in a recent policy brief prepared for Peterson Institute for International Economics, a prominent free market think tank in Washington. The ANZ economist’s paper looks at the history of the sector, identifies the challenges it faces and notes the strong fundamentals that support the industry.
So let’s start with the state of the sector, which is a key growth engine for the world’s second largest economy. New home sales for all Chinese cities, big and small, dropped sharply in the first half of the year and the inventory of unsold new homes has also risen quite dramatically since the fourth quarter of 2013.
It is estimated that it would take anywhere between 14 and 24 months to sell off all existing inventory in Chinese cities. This is in sharp contrast to last year’s buoyant sales and rapid prices increase. The fears are that this could be the inflection point, triggering a wave defaults that could bring down the country’s economy.
However, Liu believes the “fears about the China’s property sector are likely to be overblown,” and he explains why in his detailed policy brief.
Despite the dramatic expansion of China’s real estate sector, it is still a relative young sector. Widespread private ownership of property didn’t really take off until 1998, and, as a result, mortgages outstanding are only slightly more than 10 trillion yuan or $1.9 trillion. This represents only 14 per cent of total bank loans in 2013.
Unlike the subprime mortgage crisis in the US, the average quality of Chinese mortgages is high, in fact, it has the lowest default rate among all types of loans. It’s not hard to see why, home buyers need to make down payments of at least 30 per cent before qualifying for a loan. In megacities like Beijing and Shanghai, that down payment requirement is 40 per cent.
So in short, Chinese households are much less leveraged than their peers elsewhere, especially when compared with the US. Due to the lack of alternative investment options in the country’s underdeveloped financial markets, many households view property as a good store of value. This has helped to lift the country’s savings to a massive 50 per cent of GDP.
One of the strongest fundamentals that will help support the property sector is the ongoing process of urbanisation in China. The State Council, China’s cabinet, estimates that another 200 million people will migrate from the countryside to cities by 2023, twice the number that made the move since 1990. By the start of the next decade, it’s estimated that China will have an urban population of 920 million, which will lift the urbanisation rate to above 65 per cent.
Despite the explosive growth of concrete jungles in China, the country has a surprisingly low urbanisation rate. At present, only 54.5 per cent of the country’s estimated 1.4 billion people live in cities. If we take out all those people who are not officially registered as urban residents according to the country’s Hukou system, the true urbanisation rate could be as low as 35 per cent.
Liu believes China’s urbanisation process will provide strong support for both the property sector and infrastructure investment. It’s estimated that around 40 trillion yuan or $7.5 trillion will be ploughed into infrastructure over the next two decades.
Though many analysts point to soaring house prices as a sign of an emerging property bubble, Liu counters this argument by noting that the data is skewed by the huge price increases in first-tier cities like Beijing, Shanghai and Guangzhou.
In fact, the average urban house price is only 5,850 yuan per square metre, according to the official statistics. This means that China has a national price-to-income ratio of 6.1, which is towards the lower end of the international norm of between 6 and 8.
We have all heard, read and watched stories about China’s infamous “ghost cities” and many commentators have seized on that as yet another sign that a property asset bubble is emerging. Liu’s paper puts that observation into historical perspective by arguing that demand for property has outstripped supply over the last ten years.
“Demand has outstripped supply by 144.6 million square metres per year in the face of rapid urbanisation, which has driven prices higher,” he says.
“While the latest data may reveal a temporary oversupply, inventory does not appear to be a major issue.”
It is prudent to not to downplay China’s property risk, but at the same time, it is equally useful to establish some basic facts about the property sector before we scare ourselves to death. Tomorrow, China Spectator will look at Liu’s assessment of the downside risks to the industry as well as available policy tools.