Though
different, the Greek and the US public debt crises threaten
a return to the Great Recession of 2008. The world is
therefore savouring the reprieve provided by their temporary
resolution. But before that ephemeral benefit could
be enjoyed comes news of a potential new global economic
threat from an unsuspected source: China.
Its source lies in the boom in China's property market
over the last few years, which gathered substantial
momentum in the wake of the huge post-crisis stimulus
provided by the government to the economy. With a significant
share of that stimulus diverted to projects that increased
demand for real estate, price increases have been so
large that the spiral is now being identified as a bubble.
Moreover, that bubble, some observers expect, is likely
to burst in the near future for three important reasons,
among others. The first is that the huge, speculative
investments made in this sector, especially in housing,
to cash in on the price spiral, has resulted in excess
supply in many markets, with housing properties lying
unsold and unoccupied.
The second is that even as the problem of oversupply
was beginning to be sensed in some quarters, the government
strengthened its efforts to rein in the housing boom,
partly to dampen speculation and prevent a bubble. This
was partly because grossly unaffordable housing in the
cities was making the government unpopular.
The government was also responding to evidence that
its huge stimulus package aimed at moderating the effects
of the global crisis was resulting in inflation in the
prices of real estate. In addition, the housing and
infrastructure boom was contributing to commodity price
inflation. To address these issues, it sought to persuade
banks to demand larger down payments from clients, increase
mortgage rates and restrict lending for multiple housing
investments.
Finally, there is the possibility that many who borrowed
to finance their housing and real estate purchases may
find it difficult to service their debt, since interest
rates are being raised to cool an overheated economy.
This could increase defaults and foreclosures, bring
more housing property to the market, as well as limit
additional demand.
Put together these developments are expected to result
in a supply-demand imbalance that would reduce house
price inflation and even trigger a fall in housing prices.
That, in turn, is expected to prick the speculative
bubble, leading to a bust in the form of a downward
spiral of real estate transactions and real estate prices.
The argument seems to be that since government intervention
is occurring a bit too late, it is contributing to the
onset of a crisis rather than stalling the forces responsible
for the build up to the crisis.
Since the prolonged property boom in China had generated
a fair share of sceptics who were expecting a bust,
this kind of speculation has found much favour. It gained
immediacy recently when housing price indices based
on prices in 70 cities rose by just 0.2 per cent month-to-month
in May and a lower 0.1 per cent in June. On an annualised
basis, housing price inflation at 4.2 per cent was,
in June, significantly below the 6.4 per cent inflation
in consumer prices. The boom was indeed showing signs
of tapering off. Was this the prelude to a slump? As
if to answer yes, in April, rating agency Moody's downgraded
China's property sector from stable to negative. This
both reflected the mood among investors as well as served
as a signal to the more nervous among them.
All this has proved enough for a growing sense of fear
about China being the next epicentre of a crisis. A
collapse of the property boom in China would have major
repercussions domestically. To start with it could dramatically
slow growth, since GDP expansion in China is driven
substantially by investment, and investment is driven
largely by construction, especially of housing and infrastructure.
The real estate market is also a major source of revenue
financing state expenditures at the provincial level.
The sale of land to developers is a major source of
revenues for provincial governments, which then put
the money to finance prestige infrastructure projects
aimed at attracting investments and winning political
attention. If the housing boom trips so will a lot of
this infrastructure spending.
Also, a substantial amount of this state spending is
financed by credit from the banking system, which tends
to view the real estate owned by local governments as
the implicit collateral that warrants huge lending.
There has been much concern in recent times about the
volume and quality of lending by the banks. The first
official overall estimate of local government debt in
China has placed it at Rmb10,700bn ($1,650bn), or close
to 30 per cent of GDP. Clearly, banks lending to local
governments have believed that these governments will
not default because they have enough resources such
as land to pay off the banks when faced with a crunch.
The confidence in such judgements seems to be weakening,
as reflected in the fact that some investors are moving
out of stocks of Chinese banks that are not doing too
well.
Fears about bank fragility also come from the direct
exposure of the banks to the housing market and to real
estate developers. Such exposure has been estimated
at 20 per cent of bank advances. If this market sours,
the hit on banks transmitted through provincial governments
will only be compounding a significant level of direct
damage. However remote that possibility, rating agency
Fitch has decided to save itself from possible ignominy
by warning Chinese banks of asset quality risk and declaring
that there is a more than reasonable chance of a banking
crisis by 2013.
Despite all this, China fears are by no means dominating
the headlines. There is much happening elsewhere, in
the US and Europe, to keep financial news enthusiasts
preoccupied. Further, there are other factors indicating
that China may not be anywhere near the brink of an
economic precipice. Stress tests, though unreliable
even in the best of times, have indicated banks can
easily handle a property market downturn. The average
Chinese household is not overly indebted with the ratio
of household debt to disposable income placed at less
than 50 per cent.
Moreover, house ownership even in urban, let alone rural,
China, is not very high relative to the population of
households. Urbanisation is set to accelerate, with
300 million expected to move to the cities over the
next 20 years. With income rising and the government
encouraging private ownership of housing, demand is
likely to be sustained, even if not just for the luxury
housing that is the market that is possibly losing some
of its steam. Finally, housing construction is unlikely
to slow because of the government's decision to make
the provision of subsidised housing one of its instruments
to address the growing inequality in the Chinese economy.
The state plans to deliver 36 million subsidised houses
over the next five years. If it goes even a part of
the way on delivering on that promise, the construction
boom would continue.
All this said, the fear of a housing and real estate
downturn in China is understandable. These sectors directly
and through the contribution they have made to China's
growth have also partly helped prop up the global economy.
They are the sectors that draw huge quantities of steel,
cement, household fittings and accessories, the direct
and indirect demand benefits of which flow to the world
market. China is not just an exporter, but an importer
as well. So everybody is interested in a stable China.
Fortunately for the world, the state is still a major
player in China. And the signs are that it is responding
to the danger in more ways than one.
* This article was published in
the Frontline, Vol. 28-No. 17, August 13 - 26, 2011
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