Property price bubble in China- Part II

 Read the earlier part here

However, the property prices are showing increasing chances of the creation of a bubble- in fact if we consider the city of Shanghai, real estate prices increased by more than 150% between the years 2003 to 2010. The price of property to income ratio in places like Beijing is at 27 to 1 for double households (54 to 1 for single income households) which is nearly 5 times the global average. The high price to rent ratio of 500:1 as against the global average of 300:1 also indicate in this direction. Besides this, the amount of property traded in the secondary market to the primary market is in the ratio 1:4 which implies that almost four new properties are being purchased as compared to purchasing through re-sales. This figure is quite opposite to that of a booming real estate market like that of Hong Kong where the ratio is 7.25:1. This means that it is quite difficult to resale a property in China once the purchase has been made as compared to any other major location.   

Another interesting thing has been the events in the city of Wenzhou, widely regarded as the entrepreneurial capital of China.  Wenzhou has been hit by a string of large scale shutdowns raising doubts about whether the Chinese growth story is finally reaching a point of slowdown. This event has claimed several victims so far and has forced the central government to consider issuing loans to entrepreneurs at lower rates. Chinese companies freely engage in making capital gains through investment in properties and these gains reflect in its balance sheet and make it appear far more profitable than it actually is. In fact many of these firms believe real estate gives them a far higher return than their core business. The World Bank in its report has suggested that China needs to raise interest rates if it wants to contain the risk of a property bubble. Chinese premier Hu Jintao has also recently hinted that the prices are at alarmingly high levels and there needs to be correction in prices. This has been marked by tightening of interest rates by China’s central bank. Standard and Poor has also downgraded China’s real estate market to negative from stable due to tightening of interest rates and falling sales. So the real question that actually hinders around us is can china actually allow the property prices to fall?

Nearly 50% of the revenue for the Chinese government comes through land sales. A fall in the property prices will have a significant impact on the country’s GDP. According to Andy Xie, an independent Shanghai economist, “China’s property prices are a massive bubble”. To a large extent the problems for China are twofold- on one hand it needs to tighten its monetary policy to contain the bubble, on the other hand it also needs to provide cheap loans to its industries which in turn will end up investing in the property boom. 

In fact in January this year, Chinese government introduced a property tax ranging from 0.4 to 1.2% across several cities on a pilot run basis along with higher down payment of 50 to 60%. In addition to this, the city of Chongquing had introduced a special tax for property deals in secondary market by those who have no business or employment interest in the city in order to kill speculation.  These measures have led to relative cooling of prices, however it is not easy to control it as China’s bureaucracy will find it extremely hard to control speculators especially those with strong links to the communist party.

In case the vested interests of those in power are considered while making the major decisions regarding price level, Beijing will probably initiate more relaxed norms for repayment of loans and also create more tax free zones which will in turn create the push for real estate development in these towns. In addition to this, it might implement the following:

Revising the Hukou policy: China has long controlled the migration of people from one region to another especially from the economically backward western regions to the extremely affluent eastern coastal regions. At this moment of time, nearly 45% of China’s population live in the urban regions but based on the development of its economy this figure should be close to 60 %. If china relaxes the Hukou norms that will enable this excess property space created to be fully utilized.

One house norm:  Government laws still do not allow purchasing more than one house even in large cities like Beijing for non-Beijing residents.  This norm should be relaxed.

Target the DINK population:  Targeting the “Double Income No Kids” segment can be another interesting way to sustain the property prices. This segment of the urban population has tremendously high level of dispensable income and should be allowed to purchase the second house.

Allow leasing: Just like China has evolved leasing as an industry in rural areas where farmers can get land on lease and indulge in all sorts of farming activities, in a similar manner, properties should also be allowed to be taken for a 30 year lease period without any violation of the one house norm.

Allow foreigners: With the emergence of Shanghai and Guangzhou as premier business locations for people not across in Asia but worldwide, they have also become destinations where anyone would love to purchase a property. Perhaps China should look at allowing residence visas for those who own property in these locations though such a decision is unlikely to find support from the party.

In case there is an actual fall in prices of properties in China, the implications might result in a slowdown not only in China but also send shock waves all around the world. In fact the recent decision of a property developer in Shanghai to lower prices has resulted in wide scale protests from those who had purchased the properties at high prices. Analysts estimate that prices may drop as much as 20% in major locations, a scenario that looks imminent in the near future.

Summary

Over the last three decades of its great economic run, China has evolved as the largest consumer of steel and cement in the world. The fall in property prices would lead to slow down in real estate development around China thereby marking the fall in demand for steel which in turn will lead to fall in global steel prices. Now if we examine the case of cement, China has been adding capacity for cement production year on year – what happens to this unutilized capacity? It is here that China can actually play a master stroke. Its investment strategy in Africa will help it to utilize its excess capacity due to a possible slow down in a market that is growing steadily at around 7%.  At the same point of time due to lower price of steel, China will continue to import it and build capacity for future.  

“Conceal Brilliance, Cultivate Obscurity”- This philosophy of Deng Xiaoping is what guides China. In April, 2011- the economist intelligence unit access China released a report on real estate boom in China and its sustainability in future. The report signified that the property boom will lead to a surge in demand in other essentials like furnitures and cars. At the same point of time, the urban population is expected to increase by 160 million with a 2.6 time increase in per capita income by the year 2020.  So building up capacity might still end up working in China’s favour in the long run. However, in the short run, a possible correction in property prices is expected to occur.

Bibliography

1.Online edition of People’s Daily

2.Wikipedia

3.Online edition of Economist magazine

4.Super Power – by Raghav Bahl, Published by Penguin Group