Beijing’s macro tightening process is almost finished – because domestic consumption and investment are on solid ground, not because of concerns about Europe or worries of an excessive slowdown here.
Last year’s stimulus has achieved its desired results and is no longer needed. Strong wage growth, moderate inflation and very low household debt will enable domestic consumption to drive almost half of GDP growth in 2010 and 2011.
Spending on public infrastructure is down sharply from its peak, but is stabilizing at the pre-stimulus level. This is fast enough to combine with healthy levels of residential and manufacturing investment to generate about 25% fixed-asset investment (FAI) growth, which will drive the balance of GDP growth. Anemic demand in the West will result in a zero contribution to economic expansion from net exports.
By autumn, even the most pessimistic investor should be convinced that with the end of tightening, credit, liquidity and investment have stabilized at healthy rates; that inflation will remain moderate and consumption strong; and that residential property sales have begun to recover. This could be the A-share market’s winter of content.
As the stimulus was withdrawn, it was feared that Beijing would overtighten and crash the economy, despite its stated intention of slowing key macro drivers to still-healthy levels. Those levels are rapidly approaching. Growth in bank lending, money supply and urban FAI is well down from the peaks of last year, and the July figures were nearing the full-year targets of 19%, 17% and 25%, respectively.
The Communist Party controls the banks, so the lending and money supply targets should be met. It also has significant influence over FAI: Infrastructure spending, which is usually about one-third of all urban FAI, is directed by Beijing, while state-owned enterprises account for another third. This influence is illustrated by the fact that China’s FAI grew roughly 25% for six consecutive years prior to 2009, when the rate was bumped up by the stimulus to 30%.
With infrastructure spending slowing, residential real estate investment is on course to contribute 17.9% of urban FAI growth, the same as its average contribution for the nine years to 2008. Last year its share was just 7%.
Housing starts will slow sharply through the rest of the year – due to a high base in the second half of 2009 – but they are off to a blazing start, up 66% in July and 68% for the first half.
China’s residential property market is reassuringly underpinned by strong demand from owner/occupiers, low leverage, rising incomes and low inventory. The impact of recent government intervention was always going to be limited – the objective was to slow price growth in the 15 cities where prices rose at a crazy pace (33% or more) at the start of the year.
Beijing, Shanghai, Shenzhen and Guangzhou were hardest hit, but they only represent 9% of China’s urban population and accounted for just 5% of home sales by gross floor area in the first half of the year, compared with 8% in 2009. Sales in tier-three cities, on the other hand, remained up on a year-by-year basis. These cities accounted for 64% of total sales in the first half, up from 59% last year.
Residential sales volumes have fallen nationwide, prices have begun to slip on a month-on-month basis, and the proportion of buyers who are investors (as opposed to owner/occupiers) has fallen to 16% from 22% in the first quarter. Developers will ultimately respond with steeper price cuts, which will draw in buyers who have been waiting on the sidelines since April.
Sales are likely to begin rising again by October, with prices starting to recover by the end of the year. But don’t look for the government to formally eliminate the property policies it put in place in April. Instead, as in past years, Beijing will guide bankers and bureaucrats to relax enforcement of the rules in cities where price growth is seen as reasonable.
Even with FAI growth 5 percentage points down on 2009, economic expansion of 9-10% is well within China’s grasp for 2010. Last year, stimulus-enhanced investment contributed 8 percentage points to headline growth, but half of this was cancelled out by the negative drag of falling exports. The export contribution is likely to be zero in 2010, which eliminates the need for a hyper-stimulated level of investment.