The sum of all China fears

BHP Billiton's China warning comes as bank lending contractions, export woes and a property price crackdown signal the likelihood of steeper-than-expected economic slowdown.

Astute China watchers have long fretted that the Chinese government’s determination to push housing prices down could trigger a sharp slowdown in the world’s second largest economy.

Their worries appear to have been justified after mining giant BHP Billiton’s warning that Chinese demand for iron ore is likely to flatten out due to the cooling in the Chinese economy.

It’s certainly clear that China’s property market – which has long been an engine of the country’s economic growth – has slowed sharply as a result of tighter monetary conditions, and Beijing’s efforts to combat rising property prices by pushing up deposit requirements, and introducing restrictions on people buying their second and third homes.

In January and February this year, the value of property sales was 20 per cent below the level in the same two months of last year. This is the heaviest drop in sales since the Chinese property slide in 2008.

At the same time, the latest figures on property prices show that prices fell in February from January in 45 of 70 cities. The average decline across the cities is now around 1.5 per cent year-on-year, which again is the sharpest decline since 2008.

But the Chinese government isn’t resting on its laurels. It clearly wants to see steeper declines in property prices in order to stave off social unrest. Last week, Chinese Premier Wen Jiabao sparked a sell-off in the Chinese stock market by saying that Chinese house prices remained too high.

Speaking at a nationally televised press conference, he said that "home prices are still far from returning to reasonable levels, and as such, regulation cannot be relaxed.” If controls were relaxed at this point, he warned, there would be "chaos in the real estate market”.

Many economists are worried that an even deeper slowdown in the Chinese property market – and some are tipping that Chinese housing starts could drop by up to 15 per cent this year – will cause major ripples throughout the Chinese economy, particularly for construction-related industries such as steel.

At the same time, a sharp slow down in the property sector will put even more pressure on the finances of the local governments – which depend on property sales for at least half of their revenue. As the Chinese property market has deteriorated, the revenues of local governments are being tightly squeezed, and this could force them to scale back their plans for infrastructure spending, which will further dampen growth.

The crackdown on property prices comes at a time when there are clear signs that China’s exports are clearly being hit by the spreading recession in its largest export market, Europe. At the same time, the disappointing levels of bank lending suggest that the slowdown in China’s domestic economy could be steeper than most analysts are expecting.

According to figures from the People’s Bank of China, banks made 1.4 trillion yuan of new loans in the first two months of the year, which represents less than 20 per cent of what analysts estimate is the central bank’s annual lending target of 8 trillion yuan. Now, Chinese banks typically lend heavily in the early months of the year, with loans in the first two months usually accounting for 25 per cent of their total lending for the year.

Although the Chinese central bank was quick to cut the reserve requirement ratio in order to encourage the banks to lend more, some economists argue that the major problem is that demand for new loans is beginning to dry up.

They argue that Chinese companies are now responding to the problems in the property market, the slowdown in the domestic economy and the darkening outlook for exports by scaling back their investment plans. And their concerns appear to be reflected in the latest lending figures. Typically around half of the loans made by Chinese banks are medium-to-long term loans (for major investment projects). In the first two months of the year, Chinese banks only lent 25 per cent for longer-term projects, and made up the shortfall by bulking up on shorter-term trade finance loans.

However, with the major transition in the Chinese leadership due to take place later this year, the risk is that the Chinese government will be preoccupied with engineering a reduction in property prices in order to promote social harmony and that it will be slow to respond to signs that the Chinese economy is slowing sharply.