Is China’s hard landing already happening?
Since I wrote an article a few days ago about a potential hard landing in China, precipitated by monetary tightening, I wanted to flag something I put in the links this morning. It is entirely possible that the tightening which has already occurred is creating the pre-conditions of a hard landing right now.
There were two articles on China of note. The first was on the decline in Beijing house prices, where prices were down a massive 26.7% month-on-month in March. While this might be some sort of statistical aberration, it is important to note that transaction volume is slumping, a sure sign that the market is weak. The Business China article begins:
Prices of new homes in Beijing dropped 26.7% month-on-month in March, the first fall in 19 months, the Beijing News reported on Tuesday, citing unsourced data.
New home prices in Beijing averaged RMB 19,679 per square meter last month, down 10.9% year-on-year, the first annual drop since September 2009, the paper said.
A month earlier, home transaction volumes in Beijing slumped 70% m-o-m, thanks largely to the 15 new property rules unveiled in line with the State Council’s eight guidelines on the property market.
The city’s home transactions continued to fall in March, posting a decrease of 48% from a year earlier, a trend experienced by a large number of major cities monitored by the China Index Research Institute (CIRI).
Home transactions in those cities shrank 40.5% year-on-year on average in March, according to CIRI data.
“The reduced transaction volume indicates the government’s policies have been effective in curbing speculative buying, and as far as I know, around 90% of the transactions were made by home buyers with actual demand,” a person from the Beijing Municipal Commission of Housing and Urban-Rural Development was quoted as saying in the report.
After the introduction of the home-buying restriction measures, the proportion of non-local buyers of second homes in Beijing dropped by more than 40% to only 7.6% of total buyers, the paper said.
Now, two month ago, the China-focused blog Sinocism reported that this ‘Beijing for Beijingers‘ policy was going through.
The new Beijing real estate regulations are the harshest in the country. The most noteworthy new rules may be the restrictions on non-Beijing residents and the limiting of Beijing families to a total of two houses. Expect a cottage industry to develop around fake divorces, fake marriages to poor Beijing residents, and “renting” of Beijing residents’ identity cards to allow people to exploit loopholes and buy property.
Beijing real estate is expensive, in part because it is a national and to some extent international housing market. Rich people from all over China buy property here, as Beijing is the center of power and has the best education and health systems in China. Many in the global Chinese diaspora have also purchased homes in Beijing. Apparently the rules for foreigners buying residential property have not changed; foreigners can still buy one home if they can prove they have worked or studied in Beijing for more than a year.
These new measures will impact the housing market, though many analysts are not convinced prices will drop. Most believe transaction volumes will dry up and rents will increase. If the government keeps these new rules in place for a significant period of time, rather than retreating in the face of pressure from the real estate lobby or a significant economic slowdown, some developers may feel enough financial pain that they will have to cut prices to generate cash. The recent restrictions, which do not appear to apply to commercial and retail space, may drive up prices for commercial property, as in these inflationary and uncertain times people still want to own real estate as a hedge.
The social and political implications may be even more important than the economic ones. Forget the much discussed hukou reform; between these new housing rules and the recent rush hour restrictions on cars not registered in Beijing, Beijing has explicitly reiterated that non-Beijingers are second-class citizens.
At this stage, it appears that the policy is crushing house prices in Beijing. There has been an equally precipitous fall in transactions. But the fall in transaction volume seems to be widespread, with a fall of just over 40% year-on-year in major cities. This suggests that the residential property market in China is going through a down phase that might see a significant decrease in prices. It’s still early days, but this bears watching in view of out of control inflation and further potential tightening. As I indicated in my hard landing post, this does set up the possibility of contingent loss liabilities due to land price speculation being crystallized on the balance sheet of Chinese municipalities and Chinese state banks. The ratings agencies are on to this. Fitch has downgraded China’s long-term local-currency issuer default rating to negative from stable.
The second important article in the links reads:
"The negative outlook reflects concern over the scale of sovereign contingent liabilities and risk to macro-financial stability arising from the very rapid pace of bank lending in recent years, especially against the backdrop of rising real estate valuations and inflation," said Andrew Colquhoun, head of Fitch’s Asia-Pacific Sovereigns group. "Fitch expects some sovereign support for the banking system will be required," he said.
Note that the scenario postulated by Victor Shih on the allegedly fragile state of China’s FX reserves becomes operative if we see this kind of property crash and loan loss outcome. Shih argues that If China does have a hard landing due to a real estate crash, then capital flight becomes a real risk.
This would crimp growth and could spark civil unrest. China would like to avoid such a scenario. Zero Hedge quotes Goldman Sachs as noting a loosening of Chinese monetary conditions as a result. They see an inflation fighting bias and foresee further tightening nonetheless.
This loosening of monetary conditions tend to boost domestic demand growth which is likely to raise concerns about near-term inflation pressures amid continued strength in exports growth (the latter has maintained sequential growth of 40%+ qoq ann. in 1Q2011). While 1Q2011 overall monetary conditions are still tighter than they were in 4Q2010, we believe further tightening measures should and will be implemented in 2Q2011. The State Council meeting on Wednesday made it clear that the government is still putting control of inflation as the policy priority and, equally importantly, specifically emphasised the importance of using monetary policy tools to achieve that goal which gives us the confidence that inflation will be kept under control. We continue to expect further hikes to interest rates, the reserve requirement ratio, continued relatively rapid appreciation of the currency and quantitative controls to be used in the coming months until there are clearer signs of softening inflation.
If China does continue to tighten to fight inflation as I also indicated I expect they will, the hard landing scenario is definitely something to consider. Early evidence shows that the property bubble is coming off the boil. But it is doing so in a very dramatic way.