The Chinese Communist Party has an excellent track record of managing the economy in recent years – with the exception of the residential property market. After home sales volumes rose 27% in 2007, leading to a strong rise in prices, the Party launched new restrictions on property sales and financing. But officials over-tightened, crashing the market in 2008. Transactions fell 15% year-on-year, although primary market prices declined only slightly, as most buyers and sellers were content to wait out the government.
Unwilling to tolerate an artificially moribund residential market, especially in the midst of the global economic crisis, the Party lifted restrictions in 2009. The market roared back: sales rose 45% and prices in many place jumped 25%. That huge rebound in sales and prices led to another round of tightening in April 2010, when controls on home purchases, mortgage availability and bank lending to developers were resurrected. In most Chinese cities, these restrictions have blocked even those capable of paying with cash from buying a new apartment, all in the name of reducing sales volumes and price growth.
The impact of these policies on the residential market has grown steadily. The picture isn’t yet dire, with national sales up 9% y-o-y, compared to 8% growth in 2010. However, even that figure is down sharply from the national average of 22% between 2000 and 2009.
The biggest question now is whether officials will choose to maintain restrictions so long that they trigger a market crash. Answering that question is difficult, largely because it isn’t clear what the Party’s policy objectives are. They have not announced specific targets.
Some observers argue that the central government wants house prices to fall; CLSA thinks this is only partially correct. We believe the Party wants to use its controls to force developers to announce significant price cuts for new projects. The benefit of these price cuts is that they generate the media headlines the Party is looking for, as part of an effort to persuade working-class Chinese that the government empathizes with those priced out of the new-home market.
But we do not believe the CCP, or any other ruling party globally, wants to force prices of existing homes to fall by a significant amount. This would be political suicide in any country, especially in China, where we estimate that over 80% of families are homeowners (about one-third of those own the former government apartment transferred to them, a nominal cost, a decade ago). Middle-class and wealthy families – including a large share of Party members – would be (rightly) outraged if the Party were to deliberately destroy the value of their largest investment.
In our view, the Party’s aim is to prompt widespread discounts in the primary market, but stop short of forcing significant falls in secondary market prices. This would be similar to 2008, when government restrictions pushed transactions down by 15% y-o-y, but the rules were relaxed before prices of existing homes fell.
We don’t think the Party is quite ready to ease restrictions, given that national sales volumes are still up 9% y-o-y and only a handful of developers have discounted primary-market prices. In November, the central government blocked an attempt by Chengdu to relax its home purchase restrictions. Additionally, Li Keqiang, the vice premier (and premier-in-waiting) managing housing policy has said that “measures to control the property market are at a critical stage.” According to Xinhua he stressed “that the government should stick to its tightening measures over the property market and consolidate the regulatory results it has achieved.”
The internal debate
We envision an ongoing debate among senior Party officials. One side – call them the housing hawks – argues that the current restrictions will force widespread, significant price cuts in the primary market, without leading to material cuts in the secondary market. Along with large-scale construction of low-income housing, this would convince the masses that the Party is on their side in the housing sector. The hawks note that discounting is still limited, and argue that if the restrictions are relaxed too soon, volumes and prices will rocket back up as they did in 2009.
The other side – call them the moderates – argues that while primary-market price discounts are important, the Party should not to push too far. They want to relax restrictions before volumes fall so sharply there is a negative impact on the broader economy. They note that residential property accounts for about 6-7% of GDP; that about 25 million migrants work in the construction sector, and unemployment is certain to rise in the export-processing sector next year; and that residential investment accounts for about 15% of overall fixed asset investment, which is the main driver of GDP. In our view, there is a 75% probability the moderates will win the policy debate this time, in part because they can point to the costs of keeping the restrictions in place too long in 2008.
As a result, we expect to see policy easing by the second quarter of 2012. We don’t expect the Party to hold a press conference – that would only precipitate a big jump in sales and prices. Rather, by next summer we expect to see some cities quietly, gradually relax enforcement of some of the controls. The absence of a formal announcement won’t prevent homebuyers, or equity investors, from quickly hearing about the policy changes.
There is a chance that the hawks will win the debate, and restrictions will remain in place into the second half of 2012. If that happens, China runs a serious risk of a property market crash that could spill over to the rest of the economy. We think there is a 25% chance of this happening, making it the biggest single risk to the Chinese economy next year.
The overall negative impact would be limited, probably resulting in one or two quarters of 6-7% GDP growth. (Remember, extremely low homeowner leverage means there is no housing finance bubble in China.) The Party would probably also implement another large economic stimulus program. During the few quarters of slower growth, unemployment, especially among migrants working construction, would rise. Growth in demand for steel, cement and autos, all sectors that benefit from property development and sales, would slow.
Slower land sales leading to slower revenue flows into local governments would constrain their investment spending, but it would not cause a crisis. The central government, which is flush (revenue is up 28% this year, on top of a 21% rise last year), would increase fiscal transfers to locals so they can keep building infrastructure and continue to repay their bank loans. There will not be any local government defaults on bank loans, as these flows are all intra-Party.
Perhaps the most serious consequence of a policy-induced property market crash would be a loss of confidence among Chinese people in the Party’s policy management skills.
Andy Rothman is the chief macro strategist at CLSA Asia-Pacific Markets