Rising housing prices have become the topic of debate — and unrest — in China, and the central government has few options in trying to curb costs. Reining in prices too hard could result in bursting bubbles, an intimidating prospect for the Chinese economy.
As China prepares for the third plenary session of the 11th National People's Congress (NPC), to begin March 5, the rise in home prices has become a topic of vociferous debate. After viewing a number of documents relevant to the session, Yin Zhongqin, deputy chairman of the Financial and Economic Affairs Committee of the NPC, declared March 3 that "there is an undisputable bubble" in China's property markets. The Chinese central government is limited in its available responses to this problem, aside from enabling the public to vent its frustrations over increasing housing costs and ordering adjustments in policy to try to moderate price growth in select markets. Leaders in Beijing know maintaining economic growth remains the first priority in an uncertain global context and that too harsh a crackdown on real estate markets could trigger another slowdown. The presence of a real estate bubble in China should come as no surprise. Any country with a population of 1.3 billion, heavy population density in core regions and rapid development and urbanization (with the rural population falling from 80 percent in 1980 to less than 55 percent today), will see property prices boom. Add to this the endless stream of state-subsidized credit for developing companies and a financial system that offers few choices for private investors who turn to real estate as investment vehicles, and an even more inflationary environment is created for housing prices. Despite the furious tempo of construction, speculators buy much of China's housing, while the supply of homes for the majority of people remains limited and prices out of reach. In STRATFOR's China Files: Real Estate analysis we discussed the origins of China's housing boom. In 1998, the government privatized the housing market and cut welfare housing provided to urban employees. This created a new concept of home ownership as a financial investment, setting the stage for future housing bubbles. Housing price growth is exacerbated by collaboration between state-owned banks, real estate developers and local governments. An underdeveloped financial system ensures real estate investment is more profitable than bank deposits, bonds or stocks. Local governments are in control of selling land and directing loans from state-owned banks. This makes it easy for local officials to give cheap loans to real estate developers to build more profitable luxury housing, rather than affordable family homes. These properties are then purchased for investment by speculators or by state-owned firms — regardless of whether the properties are actually utilized (vacancy rates can run as high as 30-60 percent, depending on the region). As long as housing prices continue to rise, these groups profit. Local governments get an average of about 17 percent of their revenues from land sales (and sometimes as high as 40 percent), banks are able to roll over their loan sheets and accept expensive property as collateral, and developers are guaranteed a steadily increasing amount of business, especially from wealthy investors. The rapid growth of housing prices has been dramatically worsened by an expansion of lending from 2009-10. In 2009, Chinese banks lent a record 9.6 trillion yuan ($1.4 trillion) in new loans — roughly one third of GDP — to stimulate the economy after a downturn in export markets in 2008. Of these new loans, 20.9 percent — or $293 billion – were diverted into property markets, contributing to overall real estate investment in 2009 that reached about 11 percent of the country's 33.5 trillion yuan ($4.9 trillion) GDP. New investment in residential buildings grew by 14.2 percent in 2009 compared to the previous year (totaling about 8 percent of GDP), while newly constructed housing prices across the country grew by 11.6 percent compared to the previous year. In January 2010, prices on "ordinary" sized houses (less than 90 square meters) grew by 15.9 percent compared to the same period of the previous year. Moreover, the credit surge continues with the government likely to exceed its 7.5 trillion yuan ($1.1 trillion) target for the year's total loan growth. Thus, regardless of attempts to cool real estate markets, investment will remain strong and housing prices will continue to rise. (click here to enlarge image) Real estate development and housing price bubbles are highly localized. Since housing reforms in 1998, an overwhelming majority of real estate development has been in China's first-tier cities — mostly the booming economic and political metropolises on the coasts. Beijing and Shanghai have averaged more than 30 percent of GDP in annual real estate investment over the last decade, compared with a national average of 7 percent of GDP. First and second-tier cities in coastal regions are particularly vulnerable to housing bubbles, because of rapid urbanization and real estate investment. Shanghai, Beijing and Shenzhen (Guangdong Province) have been vulnerable to housing bubbles in the past with rapid housing sales one year followed by years of low or negative growth. Shanghai experienced a housing boom and bust in 1998, 2004 and 2007. Yet in 2010, the housing boom has spread to second and third-tier cities. After negative sales growth in 2008, Beijing, Jiangsu, Shanghai, Guangdong, Fujian and Zhejiang have seen record sales growth of over 40 percent, compared to national average growth of 19.9 percent. With bubbles emerging in new places, the risks of coping with an eventual slowdown become more difficult to assess and manage. (click here to enlarge image) Residential housing prices have been growing rapidly since March 2009. In particular, cities in Guangdong Province (especially Shenzhen, Guangzhou and Zhanjiang), Zhejiang Province (Ningbo, Wenzhou, Hangzhou and Jinhua) and Jiangsu Province (Nanjing) saw residential housing growth of more than 20 percent in December 2009 and January 2010. Beijing has been one of the worst hit by this housing boom, with 22.6 percent year-on-year housing price growth in January and 76 percent year-on-year sales growth in 2009. The central government responded to housing bubble concerns in January with measures to slow the growth of lending across the country. The People's Bank of China, the central bank, has acted to moderate lending. It has twice told banks to set aside a greater percentage of deposits as reserves, thus reducing the amount available to lend. Many banks have started to raise preferential interest rates and down payments for first-home mortgages. Also in January the State Council — roughly equivalent to China's Cabinet — issued broad orders for local governments to rein in real estate prices. Some policy has been enacted, such as reducing housing sales tax exemptions and enforcing down payments on purchases of second homes, and in Beijing property sales of newly built homes declined month-to-month by 15.5 percent in February. However, the New Year holiday slowed down all activity that month and it remains to be seen how effective these and follow-on measures will be in restraining price rises across the country. One of the primary forces behind the government drive to restrain prices is concern for the social ramifications of not doing so. Both the rapid progression of land development and the spike in property prices have fomented unrest. People frequently are evicted from their land — forcibly — so local governments can boost their coffers and make way for new commercial developments. People also find their income increases trailing behind the rise in prices, so that homes become a bigger burden on their pocketbooks or outright unaffordable. But in restraining prices, the central government must beware of popping housing bubbles. Too sudden a slowdown in lending will cut into economic activity, restrain construction and development, and hurt local governments, which are already facing heavy fiscal burdens after a year of heavy borrowing to finance stimulus projects. State-owned banks will face a substantial rise in non-performing loans if housing prices fall — at a time when the banks' capital adequacy and loan portfolios are already suspect for the massive expansion of credit in 2009. If belt-tightening measures inadvertently trigger a dramatic fall in prices in key property markets, China could face a crisis. This means that while controlling housing prices will be a focus at the annual plenary of the National People's Congress, China's legislature cannot adopt aggressive policies to reduce prices quite yet — its measures will be limited in effectiveness and mostly designed to mitigate price rises where they are most acute. Attempts to preserve people from forced evictions will be even less effective. Meanwhile, Beijing will wait for global economic recovery to become more stable and to give it more room to maneuver.