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Jun 9, 2015 | 09:01 GMT

5 mins read

In China's Housing Sector, a Short Recovery Hides a Longer Slowdown

A Mild Recovery in China’s Housing Sector Obscures A Lengthy Slowdown
(Photo by China Photos/Getty Images)
Summary

In recent weeks, China's housing sector started showing signs of recovery after more than a year of nationwide declines in home prices, home sales and real estate-related investment. The reversal comes after Beijing relaxed mortgage restrictions for second and third homes and enacted policies that include allowing local governments to swap outstanding loans for low-interest, slow-maturing local bonds. In the coming months, these measures will help stabilize real estate markets in major cities. The short-term gains in home prices and sales, however, should not be mistaken for a recovery of either the housing market or the national economy. Slow growth in the housing and construction sectors will continue for at least the next year, if not longer. The trend will affect employment in the regions dependent on these sectors and undermine China's economic and financial stability.

In April, home prices rose month-on-month in 23 Chinese cities, up from 21 cities in March and February. One city, the southern coastal commercial hub Shenzhen, experienced year-on-year price gains. These improvements over previous months, though moderate, support mounting speculation that home prices in first-tier and major second-tier cities will rise slightly over the next year, even if prices in smaller cities continue to slide. On June 2, the ratings agency Moody's Investors Service predicted that property sales would rise 0-5 percent between June 2015 and June 2016. The prediction was based on April's 7.7 percent year-on-year growth in sales volumes, the first positive growth since November 2013, and on the central government's decision in March to lower minimum down payment requirements for second-time homebuyers from the previous 60-70 percent to 40 percent.

On top of this moderate recovery, Beijing has decided to allow local governments to collectively trade up to 1 trillion yuan (around $160 billion) in outstanding loans for low-interest, slow-maturing local bonds this year. This will provide a slight boost to real estate and construction-related sectors in the second half of the year. The program, which started with Jiangsu province's May 18 sale of 52.2 billion yuan in local bonds, is set to wind down by September. It is likely that all 1 trillion yuan will be sold before then — the People's Bank of China has promised to let commercial banks use the bonds as collateral for low interest loans from the government. Moreover, recent reports suggest the program quota could be expanded to 2 trillion yuan in 2015. If the program reaches this total, it would replace almost half of all loans set to mature in 2015 with bonds, freeing up hundreds of billions of yuan for local government spending. Local governments, which depend on land sales and real estate activity for revenue, will likely filter this spending into infrastructure-related development.

The housing and construction sectors make up a large portion of the Chinese economy. For this reason, even a modest recovery in home prices and sales in the months ahead will have far-reaching benefits. Investment, most of it government-led, accounts for 47 percent of China's GDP. This is up from 39 percent before the 2008-09 financial crisis and subsequent stimulus drive and is an enormous figure for an economy the size of China's. As much as half of this investment is connected to real estate development.

Growth is Relative

Despite the positive signs in the housing sector, China is still in an economic slowdown. In the first four months of 2015, rail freight transport volumes fell 9 percent year-on-year while overall freight traffic grew by just 3 percent — well below growth rates in previous years. Power demand — often used as a proxy for China's true economic growth rate — rose just 1.3 percent year-on-year in April. While an improvement from a 2.2 percent decline in electricity consumption in March, the modest increase is certainly far from sufficient for an economy that still aims to grow nearly 7 percent this year, according to government projections. A minor recovery in home prices and sales cannot reverse this slowdown.

An increase in home prices and sales in the coming months will be restricted to a handful of the 70 cities for which China publishes monthly data. These 70 cities, in turn, are just a fraction of the hundreds of cities and townships across China that have experienced rapid real estate development in the past six to eight years. And with most being either major first- and second-tier cities or provincial capitals, it is safe to say that these 70 cities represent the healthier property markets nationwide. In short, whatever the headlines may say in the coming months, China's property markets, especially in the interior and the inland regions of coastal provinces, are likely to be far less positive.

The continuation of the generally negative housing trends outside of select areas will likely lead to a rise in debt defaults by property developers in small and medium-sized cities. Developers will suffer most in places where home price declines are amplified by a high reliance on industries that feed housing construction, such as coal, iron and steel and heavy industry. These areas will include Shanxi, Inner Mongolia and northeastern China. Although media reports of debt defaults are rare, anecdotal evidence suggests they are already rising. A worsening of the problem will also probably remain hidden. So far there are no indications of significant employment loss in the above regions or elsewhere, thanks in part to sustained growth in service industries, which Beijing has used to absorb labor left over from the construction slowdown. But in the months ahead, Stratfor will watch closely for signs of unrest in small cities and rural regions throughout northern and northeastern China.

The Chinese government has pledged 800 billion yuan in investment into railway construction in 2015, on par with 2014 investment volumes. It is also expanding investment into nuclear power development and power generation and transmission infrastructure. Expanding investment will help offset the economic and employment effects of weak private sector and local investment into construction activity in many regions. Likewise, Beijing will continue with efforts to expand private sector access to government-backed credit, especially for small, medium-sized and micro-businesses. These efforts should keep growth in more heavily urbanized coastal provinces stable. Throughout 2015, these efforts will combine with China's inherent economic and financial fragmentation to prevent localized economic, employment and financial issues from spreading nationwide. But they will not be enough to eliminate the issues altogether. For most Chinese citizens, 2015-2016 and perhaps beyond will be a time of belt-tightening and increasingly scarce full-time employment. It will be an unfavorable environment for the kinds of political and structural economic reforms China's leaders have in mind.

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