By Sara Hsu
May 09, 2014
The repercussions of a weaker property market will test Beijing’s zeal for reform.
China’s property market downturn has been officially called by Nomura’s Zhiwei Zhang and is supported by a plethora of statistics from across the nation, including falling home prices in 100 cities in April, declines in new residential property turnover, and developer funding shortages. The downturn is evident across the nation, with serious housing surpluses arising from Hangzhou, Zhejiang Province to Ordos, Inner Mongolia and beyond. Junheng Li of JL Warren Capital and other analysts have remarked that the urbanization drive and similar forces will not foment ongoing demand for urban real estate. The situation looks grim, so what can we expect now that China has passed the property price inflection point?
First, and most directly, demand for manufactured construction materials like steel beams, as well as construction services will continue to decline. The construction industry alone employed more than 13 percent of the urban work force in 2012 according to the National Bureau of Statistics. This will have knock-on effects through the economy as workers lose wages and are unable to maintain current levels of consumption. This means that as consumption by laid off workers declines, industries that usually receive the benefits of their spending (such as grocery shops and retail outlets) will suffer through the multiplier effect and will be forced in turn to contract their spending too.
Second, real estate asset price declines will have an impact on household savings. As Nicholas Borst of the Peterson Institute points out, household wealth will decline as real estate values fall, as real property is viewed as an investment, leading to a decline in consumption given the negative shock to households’ holdings. This will further exacerbate the downturn in consumption caused by declining wages, with a net effect of reducing household standards of living and potentially generating social discontent. What is more, the drop-off in consumption comes at a time when the leadership is attempting to ramp up consumption in order to move away from the current investment-led model of growth.
Third, as real estate developers continue to find themselves unable to sell their properties, they will default on loans from various sources. Property developers borrowed heavily from banks until regulatory authorities warned banks in 2012 that there may be losses in the real estate sector, after which bank loans to property developers and local government financing vehicles were restricted. Property developers turned to trust companies and other shadow banking entities to obtain funding. Recently regulators have warned shadow banking entities such as trust companies to restrict lending to the real estate sector, but at this time the move appears to be too late to prevent financial fallout. In the short run, liquidity issues will likely present a real problem to the shadow banking sector and to some components of the banking sector. If liquidity issues become severe, solvency of shadow banking entities like trust companies and third party entrusted lenders may pose a problem. Middle class households that purchased wealth management products through banks and securities companies containing shadow banking loans will likely be outraged if payments are defaulted on, if recent history is any guide. This may provide yet another source of social unrest.
This is something that the country can of course get through, but the social unrest and economic downturn caused by the real estate deterioration will challenge the leadership’s bold economic agenda, much of which is poised to begin this year. Inefficient housing markets and declining consumption will pose challenges to the intended urbanization and consumption focused policies; no one wants to purchase real estate when prices are declining and economic conditions are weakening, and consumers will be loath to expand purchasing behavior when there is ongoing uncertainty, even if they are given a stipend to do so. Expanding the role of market forces within the economy may also be a challenge at a time when markets are in decline.
In the long run, the reforms are meant to reduce dependence on investment-based growth and to expand financial and investment sources, all of which will help to prevent the inflation of asset prices and risky borrowing, so that growth is focused more on real returns and less on speculation (even though liberalized financial markets are subject to similar problems that require monitoring). The leadership will have to ride out some very negative events in the near term to truly settle into the reform process. This means that in many ways, the ambitious reform agenda will be doubly difficult to implement through the next few months.
Follow Sara Hsu on Twitter @SaraHsuChina
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