Anyone who thinks China has successfully escaped the sort of property market and banking sector crisis that has hit the United States and Britain over the past year might like to think again. The signals get more ominous all the time.
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Signs of mainland property bust increasingly ominous
Tom Holland
Sep 04, 2008
Anyone who thinks China has successfully escaped the sort of property market and banking sector crisis that has hit the United States and Britain over the past year might like to think again. The signals get more ominous all the time.
Take yesterday for example, when a planned 5.9 billion yuan (HK$6.75 billion) bond issue by China Vanke, a leading mainland developer, descended into confusion. According to reports citing the bond’s underwriter, half the issue was cancelled after failing to drum up sufficient investor interest at a price the developer liked. The company, meanwhile, insisted the offering was going ahead as planned.
Whatever the precise truth of the matter, it would hardly be surprising if Vanke’s bond issue had run into trouble. China’s whole property sector is struggling to stay afloat.
With their access to bank loans curbed by Beijing’s credit controls, and with share prices down anywhere between 50 and 80 per cent from last year’s highs both on the mainland and in Hong Kong (see the chart), China’s developers are fast seeing their funding sources run dry.
But that’s not the half of it. The same credit controls imposed late last year also tightened restrictions on mortgage lending to individual property buyers.
As a result, sales of new flats and houses fell off a cliff, and are now running at 20 to 30 per cent below last year’s levels (see the chart).
So far, property prices have mostly held up, at least according to official figures, but that will not last long. The real estate market abounds with anecdotes of desperate developers slashing prices by up to 40 per cent to secure quick sales, but still the customers aren’t biting.
This leaves the developers in an unenviable position. Although first-half earnings were supported by income booked on pre-sales made last year, their working capital has been sorely depleted by overly ambitious land purchases paid for in cash at the height of the sales boom. With revenues sliding, they are now finding it increasingly difficult to service existing bank loans. Some observers expect a wave of bankruptcies in 2009.
The situation is similarly grim in the commercial real estate market. After the building boom of recent years, as much as 100 million square feet of brand-new, top-notch city-centre office space is unoccupied, according to one estimate. To put that into perspective, it is the equivalent of 100 of Hong Kong’s 2IFC office towers sitting empty.
This is all bad news for the country’s banks. Although loans to developers make up only a relatively modest proportion of their overall lending books, if you factor in mortgages and loans to construction companies and other contractors, total exposure to the property sector could be as high as 40 per cent of commercial banks’ loan books, according to some analysts. That is comparable to US exposure ahead of the savings and loans crisis of the 1980s, or Japanese banks’ real estate lending before the property bust of 1991.
If prices now begin to slide across the board - and with demand down steeply they look sure too - things will get ugly. Already, with property values no longer rising at the heady rates of last year, highly leveraged property speculators are being forced to go to the grey market for funds to keep up their mortgage payments. As prices head south, a spate of defaults and foreclosures look inevitable, with bank non-performing loan ratios rising sharply.
Of course, the authorities could respond to a property crash and deteriorating bank asset quality by easing monetary policy. But as the experience of the last year in developed markets has shown, monetary loosening is little help once a bubble has already burst.
It seems China may not be following a different path to the US and Britain after all. It may just be lagging behind a little.
Choice cuts
As growth slows, Beijing must boost efficiency rather than support falling stock and property prices
Andy Xie
Sep 05, 2008
China's economy is facing unprecedented challenges. An asset bubble bursting at home and contracting global demand abroad are working together to slow economic growth. Exports and property have directly contributed to half the growth in this cycle. These sectors will probably stagnate or even contract over the next 12 months. Obviously the slowdown will be significant.
Many businesses, local governments and pundits are advocating ditching macro tightening (that is, lending more money) and intervening directly to prop up property and stock prices, or bail out distressed businesses. But this won't work and would be destabilising. Despite a 60 per cent decline from the peak, China's stocks are not undervalued. The problem with property is that prices are too high for buyers. The solution is lower prices.
Macro tightening, despite the rhetoric, hasn't been that strong. According to the central bank, lending by financial institutions increased by 3.1 trillion yuan (HK$3.5 trillion) in the first seven months of this year, up from 2.9 trillion yuan last year. The nominal gross domestic product expanded by 20 per cent in the first half of 2008 from last year's figure and, hence, all else being equal, the debt appetite should be 20 per cent higher.
Further, companies raised 640 billion yuan last year, or 53.4 billion a month, on Hong Kong and Shanghai markets, compared with 16.8 billion yuan a month so far this year.
Adjusting for the economic base effect and stock market conditions, incremental funding is 13 per cent tighter this year.
Is this reduction too much? The GDP deflator - the broadest inflation gauge - rose 9.6 per cent, and the consumer price index by 7.1 per cent in the first half of this year. Even by the loosest standards, China is experiencing broad-based inflation. From labour and food to energy, inflationary pressure remains intense. Unless financial conditions tighten, China could experience runaway inflation. So, a 13 per cent cut in incremental funding may not be sufficient to reverse the inflationary tide. The 15.5 per cent credit growth rate in the first seven months of the year, though slower than in previous years, is still higher than the long-term growth target for nominal GDP. If the long-term sustainable growth rate for real GDP is 9 per cent, and the inflation target is 3 per cent, the long-term credit growth rate should be 12 per cent.
The scope for credit to grow faster than GDP is limited, as the current ratio of credit to GDP is already high. Hence, while the current credit growth rate is tight, relative to the current nominal GDP growth rate of 20 per cent, it is still too high for long-term stability. For a soft landing, it is desirable to tighten gradually - that is, cut the credit growth rate gradually. Chances are, China's credit growth rate will slow for several years. There is no case for turning on the credit tap.
At the micro level, as well, a bailout cannot be justified. The problem with the property sector is plummeting sales due to poor affordability. Lending more money to developers just gives them more funds to hold inventory. While it diminishes the pressure on property prices in the short term, it leads to bigger problems later. High volumes can only be supported by low prices in the long run. The sustainable property price is probably 30 per cent to 50 per cent below the current levels. Preventing a price adjustment only leads to a dysfunctional property market.
Small and medium-sized enterprises (SMEs) employ a large proportion of the labour force. Their healthy development is vital for a good labour market. However, bailouts won't lead to a healthy SME sector. Healthy businesses must thrive through competition. China's SMEs depend excessively on price competition for survival. As China enters an era of inflation and rising costs, this strategy won't work; enterprises have to adapt, and increase their technology and quality.
Many SMEs won't be able to upgrade. Their demise will be a good thing for the economy, creating room for new entrepreneurs. This is how a market economy handles change. Government bailouts won't solve the problems.
Also, when so many earthquake victims are still living in tents, peasants can't afford to send their children to school and the sick can't afford hospital bills, how could the government justify spending money on bailing out failing businesses?
The case for loosening fiscal policy is stronger. Government-sector revenue could be twice as high as the prevailing level among developing countries, and comparable with that among developed welfare states in Europe. However, China's welfare expenditure is small by international standards. So, what's the case for such a big government?
Meanwhile, talk of stimulating consumption will remain just talk; China's household income is too low for consumption to carry the economy.
Beijing should commit to shrinking the government-sector revenue to a quarter of GDP, from about 40 per cent now. It should begin by cutting fees and taxes. For example, mortgage payments, tuition, health and life insurance should be tax exempt. Value-added tax, at 17 per cent, and the 40 per cent top income tax rate are also too high.
China must boost efficiency, not bail out failing businesses or target asset prices. Efficiency is the foundation for sustainable prosperity. Artificially inflating asset prices is like using opium: it delivers short-term pleasure but causes long-term pain. More opium only postpones the pain, but makes it worse when it finally arrives.
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