Zhou Xiaochuan, the governor of the People’s Bank of China (PBoC), stated during a meeting of G20 central bankers and finance ministers in Washington on October 6, 2016, that China will try to rein in excessive bank credit growth. His comment was apparently a response to an earlier IMF statement that China’s debt-to-GDP ratio has been “increasing at a dangerous pace.” According to the PBoC, “as global economic recovery gradually normalises, China will exert certain control over credit growth.” The comments mark a subtle shift in the priorities of Chinese policymakers. The country’s central bank is leaning towards debt control now as hard landing risks are smaller with the stabilization of industrial production and commodity prices, while the recent surge of mortgage loan and housing prices has shifted the risk towards an asset bubble.
Property Prices Upsurge in 2016
China’s property sales increased at an annual rate of 25 percent in the first eight months this year, and property construction grew 12 percent after two years of decline. The most alarming sign of the bubble is the accelerated price movement in recent months. According to the National Bureau of Statistics’ (NBS) 70-city home price index in August, new home prices rose month to month (MoM) in 64 out of 70 cities. In tier-1 cities, prices went up MoM 3.8 percent in Beijing, 5.2 percent in Shanghai, 2.4 percent in Guangzhou and 2.1 percent in Shenzhen. Tier 2 cities in Eastern China saw particularly strong MoM price increases in August. Nanjing rose 4.1 percent, Hangzhou 3.3 percent, Hefei 4.8 percent, Zhengzhou 5.6 percent, and Xiamen 3.9 percent. While property recovery has helped to stabilize domestic investment demand, the more than 30 percent year to year recent price rally across a number of big cities and the sharp increase in mortgage lending have heightened concern that the property bubble is being reinflated.
The current real estate bubble is similar to the stock bubble of 2015 in terms of the macro-economic background. In both cases, economic growth faced downside pressures, and the government tried to push credit to the economy to boost growth which led to excessively loose credit conditions. In both cases, investors believed it was the government’s intention to leverage the stock or property market to achieve its macro-economic objective. On March 10, 2015, then China Security Regulatory Commission head, Xiao Gang, said in an interview that “this round of equity market rally reflects the expectation for reform dividends. It is a cumulative effect of many positive policies; hence it is reasonable and rational. But we need to also pay attention to risks and think about how to control risks.” The media reported extensively on his statement that “the bull market reflects reform dividends” — with the story of “government driven bull market” swirling around the stock market — while his statement on risks was ignored.
This time for the property bubble, similar popular beliefs permeate the market that the government wants to push up the property market to achieve the objective of eliminating property inventory. The loosening of mortgage rules in September 2015 and February 2016 were interpreted by the market as signals of the government’s intentions. The press conference held by the State Council on June 23 this year further reinforced such beliefs. In said conference, speakers were widely quoted as saying, “China should improve the distribution of leverage among the public, corporate, and household sectors. The public and household sectors can leverage up to some extent, to help the corporate sector to lower their leverage.”
The absence of the government’s voice on the danger of the stock market bubble in 2015 and the property bubble this summer reinforced popular belief that in the summer of 2015 the government would not allow the stock market to drop; and in the autumn of 2016 it would not allow the property market to correct. The close correlation of the “policy message” and the stock market bubble of 2015 is shown in Figure 1.
Figure 1. “Policy Message” and China Stock Market
Source: Deustche Bank, WINDS
The sharp annual growth of mortgage loans in relation to the relaxation of mortgage rules is shown in Figure 2.
Figure 2. “Policy Message” and Increase in Mortgage Loans
Source: Deustche Bank, WINDS
Historically, the abhorrence of credit and the high household saving rate have made the Chinese real estate market one of the least leveraged markets in the world despite the sharp price increases. However, the cycle this time has pushed the new mortgage finance ratio to a new high of 70 percent in addition to sharp price increases. See Figure 3.
Figure 3. Net New Mortgage Finance Relative to Commodity Residential Sales Value (Percent)
Source: CEIC, UBS estimate
Figure 4 shows the sharp increases in monthly new medium- to long-term RMB household loans.
Figure 4. Monthly New Medium- to Long-term RMB Household Loans
Since April 2016, mortgage lending has accounted for such a proportion of total bank lending that the risk of funds diverting away from the real economy to real estate has become a real threat to the economy. See Figure 5.
Figure 5. Percentage of Medium- and Long-term Household Loans to Total Loans in 2016
Unprecedented Property Tightening Measures
During the National Day Golden Week holiday between October 1 and October 7, 2016, nineteen Chinese cities announced step-up macro-prudential policies to control property prices. This unprecedented policy coordination with unheard-of harsh measures demonstrated the determination of the government to rein in property prices. These macro-prudential property policies are of 4 major types: house purchase restrictions (HPR), mortgage restrictions, land acquisition restrictions, and price restrictions.
In this round of macro-prudential controls, some of the most stringent HPRs include Shanghai’s rule that non-local hukou unmarried residents cannot buy any units, and non-local hukou married couples can only buy one unit each. All cities now place a longer residency requirement and social security payment period on first house purchase eligibility. The most stringent macro-prudential measure implemented in this round of control is the tightening of mortgage down-payment rule, with Suzhou and Nanjing implementing an 80 percent down-payment requirement for second home purchases. Most of the first- and second-tier cities now request 50 percent or higher down-payments for second home purchases, and first unit house purchase down-payments in first- and second-tier cities have essentially gone back to 30 percent. Some cities have introduced land acquisition restrictions such as aborting land sales once the bidding price reaches over 50-100 percent of the reserve prices, while other cities have restricted developers from selling the second phases of the same development at prices much higher than in the first phases. Table 1 shows the macro-prudential measures implemented by selected cities and their 2016 year-to-end of September housing price increases.
Table 1. Selected Cities’ Price Increases and Macro-Prudential Policy Implemented
Source: National Bureau of Statistics, CREIS, UBS estimates
The synchronous tightening of macro-prudential measures has dampened the real estate market nationwide. While the Golden Week holiday used to be a seasonally strong property selling period, the market has witnessed a collapse in transactions. Records showed that transactions nationwide have dropped more than 80 percent in the affected cities between October 1-6 as compared to previous week of September 25-30. There have been reports this week of widespread buyer cancellations of purchase agreements and sharp price corrections.
Economic Implications of the Property Bubble
The acceleration of property prices and bank mortgage lending happened so quickly that the impact on the economy has not yet filtered down to the real economy. In fact, the recent market frenzy has successfully deleveraged the high housing stock. The tier-1 and tier-2 sales-to-inventory ratio has dropped to below the 10-month level and that is a signal of a looming housing shortage in these cities. See Figure 6.
Figure 6. Inventory to Sales Ratio in Chinese Cities
Source: CEIC, UBS estimate
The sharp increase in mortgage loans and the rising mortgage-to-property value ratio are not expected to pose any immediate problems to the financial system as the Chinese mortgage portfolio loan-to-value ratio remains low and Chinese household debt-to-disposable income ratio remains low. See Figure 7.
Figure 7. China’s Household Debt to Disposable Income Ratio Remains Low by Global Norm
Source: Merrill Lynch Global Research, CEIC, Haver Analytics
The mortgage loan portfolio is one of the best performing loan categories in the Chinese banking system and the market structure of high loan-to-value in mortgage loans protects the system more than anything else. See Figure 8.
Figure 8. Non-performing Loan Ratio of Selected Loan Category in China
The recent upsurge of property prices and activities in major cities has stabilized real estate investments and reversed the drag on fixed asset investments from the slowdown of real estate investment. See Figure 9.
Figure 9. Growth Rate of Three Major Components of Fixed Asset Investment
Source: CEIC, UBS
The contribution to economic growth from real estate construction activity is concentrated in lower tier cities. The common perception that China needs high property prices at major cities to support economic growth is not entirely true. See Figure 10.
Figure 10. Construction Activities in Chinese Cities
Source: CEIC, UBS
The speedy effort to deflate the property bubble has protected the banking system and the fear overseas of a real estate bubble trigger crisis is unlikely to happen.
Policy Challenges Going Forward
The government will face several challenges after deflating the property bubble. Foremost of which is policy calibration between different cities. This property bubble of 2016 has highlighted the location nature of the property market. In Figure 11, for the top 20 cities with the highest price increases, the concentration is on tier-2 cities. In Figure 12, the number of cities with growth above 5 percent year on year is much lower this cycle as compared to three earlier cycles. While there has been bubble-type price and volume behavior in some cities, there are other places where prices and inventory have hardly moved.
Figure 11. Top 20 Cities with Highest Property Price Increase in Four Cycles
Source: National Bureau of Statistics
Figure 12. Differentiation of City Price Pattern Emerges in This Cycle
Source: National Bureau of Statistics
Second is the damage to government reputation on macro-economic policy steering. The stock market fiasco of 2015 and the property market bubble of 2016 both reflect the herd mentality of following the “policy message.” The new economic reality that a much lower L-shape growth curve is the most likely route is apparently not yet a bought-in idea to many. The government should examine its economic communication to the people to prevent a similar recurrence.
The third challenge is the issue of how to channel such a large amount of household savings into socially beneficial investments. The propensity to follow the “policy message” reflects the dearth of proper investment vehicles to channel the unusually high savings rate of households into meaningful investments. When people bid up apparently over-valued assets, the real economy suffers from a dearth of liquidity support. This unique issue facing a high-savings society is often an important cause of asset bubbles around the world.