Analysis on the Chinese

Property Market
China"s massive fiscal and monetary stimulus to rebuff
the effects of the global downturn with ramped up
domestic demand stoked a property bubble, drawing
comparisons to the Japan and US housing bubble. The
real estate market is now vulnerable to interest rate
hikes, though it should not spark a meltdown as it did in
Japan in the early 1990s. Nevertheless further price
growth is certain, which raises risks of social tension
and economic instability.

OM Jung-Myung

Analysis on the Chinese Property Market

OM Jung-Myung

China's massive fiscal and monetary stimulus to rebuff the effects of

the global downturn with ramped up domestic demand
stoked a property bubble, drawing comparisons to the Japan and US
housing bubble. The real estate market is now vulnerable to interest
rate hikes, though it should not spark a meltdown as it did in Japan
in the early 1990s. Nevertheless further price growth is certain,
which raises risks of social tension
and economic instability.

Investment Sputs a Rebound

When the global financial crisis erupted, the Chinese government responded
quickly with economic stimulus measures. Thanks to its effective response, the
economy rapidly recovered from a trough that spanned the fourth quarter of 2008
and the first quarter of 2009, posting annual growth of 8.7 percent in 2009. The
rebound was attributable to increased domestic demand on the back of the
stimulus, as recession in advanced countries made it impossible for exports to lead
the way out of China's slump.

The stimulus action included strong fiscal and monetary expansion. Although the
fiscal deficit did not balloon to high levels compared to GDP, the amount of bank
loans and money supplies did surge to historically unprecedented levels.

The main reason for this was that state-owned enterprises (SOE) and local
governments took loans from state-run banks and rapidly invested the funds. In
2009, total new loans amounted to 9.6 trillion yuan, almost double the 4.9 trillion
yuan of 2008. Among these, loans to local governments for investment in
infrastructure and facilities1 were 3 trillion yuan,2 while those to SOEs were 3.5
trillion yuan. Accordingly, about 70 percent of the loans were aimed at investment
for economic stimulus, which served as a growth engine in 2009. Indeed,
investment, or gross capital formation, was the dominant driver of the economy,
which contributed 8.23 percentage points to economic growth. Moreover,
consumption promoted by the stimulus, such as plans to provide energy-efficient,
environment-friendly home appliances and cars at cheap prices to rural residents,
contributed 4.62 percentage points to growth. Drastic declines in exports on the
other hand, contributed negative 4.15 percentage points of growth.

Adverse Effects of the Rapid Rebound

Negative effects of the record loans and monetary expansion first appeared in the
property market. After a brief time lag, consumer prices started increasing. Real
estate is an important investment in China, where the financial market is not
advanced, and where only a small selection of products with limited gradations in
risk are available. Hence real estate investors have grown despite the global
financial crisis and uncertainties in the future. From June 2009 property price
growth has continuously reached new highs. Though the rate slowed this year,
prices remain high. Concerns of a bubble began to grow in the second half of 2009,
and further escalated in November 2009 when Dubai asked for a moratorium on its
debt. The worries were mostly about the rapid increase in new loans, which sent
property prices skyward, creating an asset price bubble. China's bubble was even
labeled "Dubai times 1,000–or worse."3

In a somewhat muted and passive response, the Chinese government tightened

monetary policy, increasing issuance of monetary stabilization bonds in the second
half of 2009, while limiting the aggregate number of eligible loans. To stabilize
property prices, the government has focused on discouraging speculation, raising
the minimum payment for the second installment in a home purchase.4 The
government also limited loans and forced higher interest rates on homeowners
buying a second home. As a result, the growth rate of property prices turned
downward in 2010. Nevertheless, property prices are still high compared to the past.

Despite the moderate cooling of the property market, the consumer price index
(CPI) has maintained its upward momentum, surpassing 3 percent growth year-on-
year in May5 this year and reaching 3.3 percent in July. As changes in CPI lag M1
growth by two to three quarters in China, consumer prices are likely to rise further
in the future. Some warn that with consumer prices steadily rising, higher interest
rates will follow, and this will burst the real estate bubble just as it did in Japan in
the early 1990s.

Indeed, the formation of China's property bubble can appear much like that of Japan
in the 1980s. The similarities include: 1) a massive current account surplus fueled
by a high savings rate and undervalued currency; 2) monetary expansion sparked
by increased foreign exchange reserves; and 3) falling real interest rates under a
loose monetary policy that encourage investors to borrow and invest aggressively
in real estate. Some Chinese media have reported that China is undergoing the
fourth phase of a bubble collapse that is taking the same course as Japan's.6 Since
China has led global economic growth since the financial crisis, careful monitoring
for a possible collapse is all the more important.
Possibilities of a bubble Collapse in the Chinese Property Market
Japan and the US present good examples of a property market meltdown and they
both exhibited common symptoms before the plunge. First, household debt was
extremely high. US household debt amounted to 133 percent of disposable income
in 2007 right before the crisis, while debt in Japan was 130 percent in 1990. Second,
the increase in real estate prices had been running ahead of growth in disposable
income from 1999 to 2006 in the US and from 1986 to 1991 in Japan. Both countries
maintained low interest rates before their property bubble burst, spurring a sharp
run up in home prices with deeply leveraged purchases; loan growth remained far
higher than income growth for at least five years.

China's price to income ratio (PIR) is among the highest in the world, and according
to some analysts, the market is frothy because housing prices are very high in
terms of income levels. In fact, China's PIR is eight times on average, 19 times in
Beijing and 16 times in Shanghai. This is very high compared to other countries:
three to six times income in the US, 7.5 times income in Korea and 5.7 times income
in Japan.
Despite such high prices, 70 percent of residents in large cities and 80 percent of
those in ordinary cities have their own house. This is because many homeowners
own homes provided by the government until the housing policy reform of 1998.
Most significantly, China's household debt is only 39 percent of disposable income;
accordingly Chinese property owners can withstand a decrease in property prices,
as they are not suff ering from high interest rates.7 In addition, the rate of increase
in real estate prices surpassed disposable income growth only in the second half of
2009, meaning that if there is a bubble in the market, it is less than a year old.

Therefore, real estate prices are high in nominal terms, but are not in practice, an
actual burden for most people. Considering the household debt ratio, the time the
bubble was formed, and the rate of home ownership, if property prices slide, it is
more likely to be a temporary adjustment and correction, rather than a warning sign
of a coming meltdown.

Low Financial Industry Exposure to the property Market

New loans for property increased 327 percent in a year from 480 billion yuan in 2008
to 2 trillion yuan in 2009, and recorded 47 percent growth in the first half of 2010
compared to the same period of 2009. However, in 2010, the share of loans for
property has remained a low 20 percent of the total, compared to 33 percent in
Korea (March 2010) and 39.2 percent in the UK in 2006 (immediately before the
collapse of its own housing bubble). As of the second quarter of 2010, loans for
property (real estate development and mortgages) amounted to 20 percent of the
total even after property prices soared from the second half of 2009.

Also, Chinese banks appear financially sound. Loans increased remarkably in 2009
as a result of government stimulus, but the loan-to-deposit ratio stood at 70 percent
in April 2010, thanks to the government's 75 percent cap. Compared to bank assets,
loans accounted for only a small amount,8 while property-related loans took only 10
percent of assets, enough for banks to cushion themselves from a plunge in real
estate prices.9 Therefore, it is highly unlikely that a property market crash in China
would trigger a series of bankruptcies among financial institutions, precipitating a
financial crisis, as it did in the US and Europe in 2007 and 2008.

Long-Term Challenges of the Chinese Property Market

Chinese property issues are directly linked to government revenue. Real estate
sales increasingly account for a greater share of local government revenue. Sales
accounted for 23 percent in 2009.10 This has prompted many analysts to predict that
the government would not control property prices, as price increases mean higher
public revenue. To maintain stable financial income, reasonable growth of real
estate prices would be ideal.

Meanwhile, most current homeowners benefited from the government housing

policy. Today's new arrivals to cities, self-employed people, and new graduates,
however, will find it hard to buy their home. Some non-owners even refer to
themselves as "house slaves," working only to save enough to buy a home.

Property issues represent not only economic, but also social, class, generation, and
urban-rural disparities. Although a bursting property bubble is improbable,
continued price growth may spark severe economic and social problems. To
prevent this, the government should maintain balance between housing price
control and government revenue.

Currently, China is facing economic and social changes resulting from a transition
in its growth commodel.11 As the property sector takes a large share in the
economy, China needs to come up with solutions to prevent property prices from
undermining economic and social stability, particularly in this transitional period.

Keywords
Chinese property market, housing loans, GDP growth, bubble collapse, disposable
income, household debt

Note

1. Chinese local governments are entitled to issue bonds but have hardly issued
any since the financial crisis, because the central government has strictly controlled
issuance.

2. Liu Mingkang (May 2010), China Banking Regulatory Commission (CBRC).

3. James Chanos, President of Kynikos Associates.

4.Home purchases typically involve three installments. The first payment is at the
contract signing. The second and third payments are at preset times that are
negotiated beforehand.

5. Premier Wen Jiabao announced his goal to suppress CPI of 2010 to 3 percent or
less in the National People's Congress in March.

6. The first phase is currency appreciation after the introduction of the currency
basket system in 2005 in China and the Plaza Accord in 1985 in Japan. The second
phase is a surge in real estate investment, as witnessed in 1986 in Japan and in
2006 in China. The third phase is economic stimulus plans introduced in 2008 in
China and in 1988 in Japan. The fourth phase is a bursting of the property bubble
induced by a rate increase, which started in 1991 in Japan, but has not appeared in
China yet.

7. Exceptions are large cities, including Beijing and Shanghai, where the rate is
higher than the average, resulting in potentially bigger price adjustments.

8. Loans accounted for 51 percent of bank assets, and the Capital Adequacy Ratio
as of June 2010 was 11.1 percent.

9. As for Korea, the loan-to-deposit ratio was 106 percent in March 2010, which
could climb to 117 percent when CD rates were not considered.

10. CEIC, 2009 Local Government Budget Implementation, 2010 Plans for the Local
Government Budget.

11. Hu Jintao and Wen Jiabao announced a transition in China's growth model so
that domestic consumption, rather than exports, can drive economic growth.