Chinese property is the most important sector in the global economy. It has been pivotal in the country’s economic development, provided lucrative business for industrial commodity producers from Perth to Peru, and been the backbone of the surge in world exports to China. In the past few years, predictions that the sector was about to implode at any moment have not been borne out – but now is the time for the world to pay attention. Property activity indicators have been trending lower since mid-2013, and the downturn in the sector now threatens to turn into a bust. At best, China is entering a deflationary phase at a time of global fragility.
The default risks in the weakly regulated shadow banking sector – and the rapid rise in local government debt – are real, and property-related. Yet the government and the central bank have tools to limit the short-term consequences; they have already deployed debt rollovers, bank bailouts and recapitalisations.
The greater risk to China lies in the pervasive consequences of any property bust. Property investment has grown to account for about 13 per cent of gross domestic product, roughly double the US share at the height of the bubble in 2007. Add related sectors, such as steel, cement and other construction materials, and the figure is closer to 16 per cent. The broadly defined property sector accounts for about a third of fixed-asset investment, which Beijing is supposed to be subordinating to the target of economic rebalancing in favour of household consumption. It accounts for about a fifth of commercial bank loans but is used as collateral in at least two-fifths of total lending. The booming property market, moreover, has produced bounteous revenues from land sales, which fuel much local and provincial government infrastructure spending.
The reason things look different today is the realisation of chronic oversupply. As the property slowdown has kicked in, housing starts, completions and sales have turned markedly lower, especially outside the principal cities. Inventories of unsold homes in Beijing are reported to have risen from seven to 12 months’ supply in the year to April. But when it comes to homes under construction and total sales, the bulk is in “tier two” cities, where the overhang of unsold homes has risen to about 15 months; and in tier three and four cities, where it is about 24 months.
The anti-corruption crackdown, often targeting individuals who have built up ostentatious property wealth, has poured cold water over the market, in which, according to a recent investment bank report, the richest 1 per cent of households is estimated to own about a third of residential property. Elsewhere, the tightening of credit terms, including funding costs for property developers, especially in the shadow banking sector, is taking its toll. Rates of return on commercial property and infrastructure, and cash flows for developers and local government, have been deteriorating.
The crunch in the property market, and for the economy, will come when land and property prices fall more broadly across the country. Official data still show that property prices in 70 cities were 8 per cent higher in March than a year ago – but prices have actually fallen since the end of 2013.
If activity levels and prices weaken further, Beijing’s resolve not to respond with traditional stimulus programmes is unlikely to hold. We should expect a potpourri that might include: extra spending on infrastructure and environment programmes; faster urbanisation in inland and western provinces; some relaxation on restraints on homebuying, such as mortgage deposits; and, ultimately, new monetary easing.
Such steps may provide financial markets and the economy with some short-term relief. But if Beijing goes too far it will undermine the essential strategy of rebalancing the economy, in which case the negative economic impact would be larger and last longer. China is different from the west in many ways but the real economic effects of a burst property bubble are the same the world over. Beijing will have to cope with them in the next two years but the rest of us should be prepared for the deflationary consequences in a still fractious global recovery phase.
The writer is the former chief economist of, and now independent economic adviser to, UBS
Get alerts on Chinese business & finance when a new story is published