The property lobby is having the upper hand…for now

Despite global weakness, Shanghai actually went up 2.1% today. This is NOT an indication of faith in the global recovery, or any recovery, but rather an expectation of loosening of governmental controls over the property market.

Due to popular backlashes against runaway housing prices, Chinese government launched a series of cooling measures in April, causing a sharp drop in turnover (Shanghai saw a fall of over 75% in turnover) but the impact on prices has been marginal so far. To date, the developers have refused to cut prices, buttressed by record profits last year. However, the war of attrition is gradually starting to bite, and an association representing the developers has plead with the central government in an open letter to loosen the controls.

Despite repeated government responses of “No”, you can’t blame the public for trusting the developers more, as previous cooling measures all ended in sharp policy reversal in the face of economic slowdown. However, I think the government will hold out for longer this time, at least for one more quarter.

1. Chinese slowdown will not be apparent until end of Q3. There’s still a wee bit of time.
2. Popular discontent with extra-orbital housing prices is threatening the CCP’s legitimacy. Contrary to western conception, even an authoritarian government has to deal with popular opinion if it wants to stay in power.
3. Housing policy is believed to be part of the portfolio of Li Keqiang, slated to the China’s next premier. Failing in a key policy initiative will become a major stumbling block on his personal route to power.

As such, I believe housing policy will remain unchanged (i.e. tight money, anti-speculation) till the end of Q3. Since I expect rapid deterioration of the Chinese economy in Q4, the government might be forced to revert its stance then.

China to ban 3rd mortgages in key cities

The Shanghai and other Asian markets have been choppy lately, mainly on the prospect of the Chinese government backing off from regulating the property market. So much so that property sales doubled last week in Beijing. Some other cities have even racked up price increases.

To prove that it’s indeed serious about pricking the property bubble, the powerful China Banking Regulatory Commission is now banning 3rd mortgages in Beijing, Shanghai, Shenzhen, and Hangzhou all together. Taking out 3rd mortgages in other cities, while still legal for now, will require 60% down payment and almost 200bp over prime rate.

Of course the central government worries about economic slowdown, but failing to regulate the property market risk serious popular discontent. With most full year GDP forecasts still in the 9%+ range, the tightening measures seem to be in place, for now.

As a side note, the 21 Century Business Herald has a follow up story on the stress test that raised so many eyebrows. Assuming a 30% drop in housing prices and 108bp  interest rate hike, the property portfolios of  sample banks would have registered 2.2 percentage point increase in their bad debts, and taking 20% hit to pretax profit.

Yes, painful, and would have been excruciatingly more so with a 60% fall in housing prices, but the system will not collapse. With the hindsight, it seems that the 60% fall stress test was ordered partly as a way to advertise to all speculators that the government is indeed serious and won’t be taken hostage by the property market. However, I expect the economy to slow dramatically in Q4, so it might have to sing a different tune by then.

How bubbly is the Chinese property market?

This is the million dollar question and I’ve decided to give it a try. Where do I start? How about the developers inventory?

The National Bureau of Statistics just announced yesterday that developer’s inventory for residential housing by the end of June at 106mn sqm, or roughly 1.5mn homes assuming an average of 70 sqm (753sf) per home. This amounts to a mere 1.5 months of new home supply on last year’s sales. Now, 2009 was a brisk year. But even if I use 2008 figure, when sales dived 20% due to the financial crisis, it equates to 1.8 months of supply, far from horrendous if you consider that the US new homes supply seldom dip below 4 months even in the best of times.

Why is this focus on new homes supply important? Due to the requirement for 30% down payment for homeowners, the weakest link for a Chinese bank is actually lending to the developers, the conduit in which the bursting of a property bubble may morph into a full-fledged financial crisis.

Of course, the tightening measures on the property market only kicked in mid-April and the data is only from end of June. Given time, it’s definitely plausible that inventory may build up further and prices may plummet (so far it has barely budged). Which is why the Chinese banking regulator is performing a stress test on the assumption of 60% pricing fall in the worst case scenario. But should this be taken as an admission that Chinese property market will indeed collapse? I think not.

According to the National Bureau of Statistics, housing price index rose 14% year-on-year by June this year. Before you scream communist propaganda, I should add that this index is compiled with data from 70 Chinese cities, with huge variance among them. Beijing registered 22% rise during the period, while Sanya of Hainan (think Florida in terms of climate, location, and economy) rocketed by 59%! Private economists, like Stephen Green of Standard Chartered, have also noted the geographical concentration of the housing bubble.

So all in, I think the coming bursting, while painful, will not be catastrophic. The froth is concentrated in a few key cities and the banking system is insulated to a degree by the down payments. The US financial crisis had its root in leverage, rather than the fall of housing prices.

China to dole out subsidies for farm produces

Despite public denial, China has seen skyrocketing prices in many farm produces. The National Development and Reform Commission, the nations’ powerful planning department, has requested that the various local pricing bureaus to issue temporary produce subsidies to low income populations.

Inflation on the ground is much higher than the CPI, partly driven by excess liquidity in the economy, exacerbating social problems that are already plaguing the nation. The top 10% of Chinese make 23x that of the lowest 10%, compared to just 7x 20 years ago. Despite all the brave talks, the government is actually deeply worried. Hence the new found hope for diluting the tightening measures may end up being just that, hope.

Brother, can u spare some beans?

With the government tightening the screws on property market, there’s a persistent worry that the liquidity might end up flooding the general economy instead. The recent runaway price increases for farm produces demands particular attention as inflation in food has a direct impact on social stability.  Garlic has gone up by 35% this year and green beans has increased by over 70% (!) since the Chinese New Year, so much so that volume for the later has dropped by 30%.

The economist of the National Bureau of Statistics has denied that speculation plays any significant part in the recent prices increases, and blames the weather instead. While China certainly  has been hit with really strange, irregular weather during 2009-10 growing season, speculation cannot be written off so easily. For one thing, the perishables generally have only mild price increases, as are produces that are grown across the country. It’s things like garlic and beans, produces can be easily cornered and stored, that have registered the most dramatic increases. Besides, the Pricing Bureau of Guangdong has recently started an investigation on hoarding. Somebody must have seen a problem.

One thing that’s for sure is that May CPI is going to breach the 3% threshold, as food accounts for 34% of China’s CPI basket, compared to about 15% for the US. (Since the poor spend more of their budget on food, the CPI of a less developed nation generally reflects this.)  Although the official litmus test is 3% for the FULL year, the breach of one single month is enough to send investors running for cover, if they haven’t already done so.