Thursday, March 13, 2014

China's view on housing prices portends major shift for economy

China's leadership gave out a subtle but important signal about its assessment of the nation's real estate market in its first annual work report, delivered on March 5 by Premier Li Keqiang to open the 2014 plenary session of the National People's Congress.

     There was no mention in this year's report that the government intends to "stop the rise in housing prices." All annual reports since 2005, except for 2009's, had this phrase.

The report is regarded as the primary instrument for the government to send out its policy messages. The assumption is that the phrase was dropped because housing prices are declining in some cities.

     It is a small change in one report, but one that could be a harbinger of a massive shift with huge implications for the Chinese economy.

Grounded evidence

Li's housing policy remarks during the first day of this year's assembly session clearly indicated a change in the government's general view of the market. Beijing will "make adjustments (to the policy) according to the conditions in individual cities," he said.

     Such change is already visible in cities like Hangzhou in Zhejiang Province.

     Immediately after the Chinese Lunar New Year in early February, the developer of the DeXin Beihai Park condominium building in the city cut unit prices per square meter from 18,800 yuan ($3,068) to 15,800 yuan. That translates into a $48,000 markdown for a 100-sq.-meter unit.

     On the following day, a nearby condo project responded with its own cuts, which angered those who had already signed contracts. Many demanded their contracts canceled.

     Shortly after these moves, Industrial Bank, a second-tier lender based in neighboring Fujian Province, announced it would suspend part of its lending to real estate-related businesses.

     All of these moves are harbingers of greater change.

Beware ripple effects

The Chinese housing market rose by more than 20% last year. Rising house values have been a major driving force of China's economic growth.

     Real estate developers have been buying huge amounts of reinforcing steel and cement used for construction and hiring droves of migrant workers from rural areas.

     House owners in cities who have handsome paper profits on their properties have been spending these windfalls on luxury foreign cars and other high-end goods. Local governments have been using income from land sales to build their own office towers.

     A major downturn in real estate prices could not just reverse this exuberance, it could also create huge financial cracks that could spread through the entire economy.

     The focus of concern is China's so-called trust products. Trust assets in the country grew to a record 10.9 trillion yuan by the end of 2013, equivalent to 20% of China's gross domestic product.

     Such products are issued by trusts, which take money from investors and lend it out to capital-intensive projects or in other areas in which banks might be reluctant to lend.

     According to the China Trustee Association, a quarter of these trust assets have gone to infrastructure, while 10% has gone to real estate. Loans to the industrial and commercial sectors, 28% of total trust assets, are also believed to include lending to real estate-related businesses.

     If falling housing prices result in the burst of real estate bubbles, the risk for defaults on trust products would surge.

Misplaced vision

The operator of the DeXin Beihai Park condominium raised money to finance the project from individual investors through trust products and privately placed shares.

     Real estate developers are chronically strapped for cash because their business of buying land, developing it and selling the properties generally runs in a two-to-three-year cycle. If they are required by banks to pay back their debts or fail to refinance their loans, they have to dump their properties at fire-sale prices. This in turn accelerates any market declines.

     Premier Li announced Wednesday that the government would seek to achieve 7.5% economic growth for 2014. The target for money supply growth has been set at 13%. Both figures are the same as 2013's targets.

     The announcement disappointed some market players who expected the government to put priorities on structural reforms and lower the growth target to 7%.

     The government's work report used the word "reform" 77 times.

     But the unchanged growth target suggests that the administration of President Xi Jinping is adopting a populist economic agenda focused more on short-term job creation and economic expansion than on the reforms needed to restructure the economy.

     As such, Beijing's reluctance to tackle necessary reforms is likely to increase the risk of a hard landing for the Chinese economy.