The Chinese government knows it has to do something about the run-away house price inflation in its major (Tier 1 and 2) cities. And it is.
As SocGen’s Wei Yao says, since late September, “20-strong cities have either reintroduced or stepped up tightening on the housing sector.”
It’s far less than the peak of 46 Yao says we saw in the previous cycle but it’s not bad going and the cities involved cover “more than 20% of national sales and new starts volume, more than 40% of national sales value, and more than 30% of national property investment,” according to RBS.
From Citi on what we’ve got so far, do click to enlarge:
And from RBS:
Fact is, regulation in China’s housing market is unshockingly cyclical — “tightening from 2Q10 to 2Q14, easing from 3Q14 to 2Q16, and now tightening again,” says Yao — and we are now in a downturn focusing, mostly, on demand suppression in particular cities.
Here’s Citi again with the boxy, historical view, highlighting the differences in this cycle. On the less favourable side, namely that “current average selling prices and volume are at record highs, overall economy is weaker”:
The questions for this cycle then are: Will the prudential moves being taken be enough to slow the housing market? If they are not, can monetary policy weigh in? And what are the consequences of a slowdown or a failure to slowdown?
The problem is that, based on past cycles, it’s unlikely that prudential measures can do the heavy lifting alone, at least not past the short-term. From Wei Yao:
Following the sharp economic slowdown in 1H14, 41 out of the 46 cities with HPRs had rescinded the tightening measures by end-October 2014. Soon after, both housing sales and prices in these cities bottomed out and started to outperform. However, in the four first-tier cities where HPRs remained in place, housing inflation and sales growth were even stronger. In our view, this development highlighted the ineffectiveness of any demand-suppressing policy in major cities where land supply had been restrictive for a long time.
As the observations above imply, past housing cycles actually followed interest rate cycles more closely than any other policy measures. In 2010, credit conditions started to tighten and mortgage rates started to rise two quarters before the quick expansion of HPRs and three quarters before the housing sector started to cool. In 2012, the PBoC cut policy rates in 1H and the housing sector started to recover in 2H, despite the continued presence of HPRs. And since 2015, the combination of monetary policy easing and absence of prudential measures has significantly inflated housing prices in major cities.
In our view, the explanation for such a tight leading correlation of interest rates over housing sales, despite the relatively low leverage of Chinese households, could be twofold. First, tightening credit conditions have an impact household income and inflation expectations. Second, the part of incremental housing demand that determines housing prices comes from those households with higher sensitivity to interest rate changes.
That said, SocGen” would not be surprised” based on the measures already taken “to see yoy contraction to the tune of 15-20% in housing sales nation-wide at some point during the next six months.” And that will impact economic growth. Do remember that housing is an incredibly pivotal part of the Chinese economy, driving other sectors before it.
However, to what extent housing and growth actually fall over a longer term will depend on the evolution of monetary policy. And it’s unclear that there is room for it do much considering the need to keep growth rates supported. As Wei Yao says:
We do not think the PBoC can afford to hike its policy rate to tame housing inflation this time. However, strict implementation of prudential measures should lead to reduced credit supply to households and developers. In order to sustain profit, banks might have incentives to raise rates on mortgage and developer loans, even in the absence of a policy rate hike. In any case, the more lenient monetary policy might be able to mitigate the upcoming downturn somewhat by supporting other sectors of the economy.
Harrison Hu at RBS expects “a property-led cyclical downturn to materialise in 2017, which seems yet to be priced in by the market and for “GDP growth to slow from an estimated 6.7% in 2016 to 6.6% in 2017.”
But, as already discussed, there are mitigating factors here. Not only have prices spiked in cities with resilient demand, meaning that said demand will likely spill out to other cities as prudential measures take effect, and where government has options on the supply side (although we haven’t seen much on that front yet), there are also decent household balance sheets that will help cushion the blow of any downturn.
More so, the fact that the previous downturn wasn’t too long ago means surviving developers and others in the industry should be better equipped this time around, see Citi’s chart above. Critically too, capital controls should still be able stop too many households shifting assets abroad and really making things awkward.
But that doesn’t mean this will definitely end cleanly. It’s clearly an increasingly difficult tightrope for China’s policymakers to walk.
From SocGen’s Wei Yao, who very sensibly says that when it comes to Chinese housing she couldn’t be more humble with her forecasts.
She sees “both upside and downside risk to our central scenario of Chinese policymakers narrowly succeeding in managing the difficult trade-off between economic slowdown and asset bubbles”:
– Good surprise – 10%: land supply increases significantly in major cities and the investment recovery gets extended. We have long argued that increasing land supply in major cities is an indispensible part of the long-term solution to the stubborn housing inflation in those cities. There have been more talks and some action, albeit far from enough to alter the near-term trajectory of either housing inflation or investment growth. However, we need to monitor the development closely.
– Bad surprise No.1 – 20%: prudential measures are offset by easy monetary conditions and housing inflation gets out of control, forcing monetary policy tightening later. China has never had the combination of tight housing policy and easy monetary conditions. The risk of prudential measures being muffled by easy liquidity conditions is not negligible. In this case, housing inflation would run further and likely transform into general inflation pressure. Consequently, the PBoC might be forced to raise interest rates outright, despite a still-fragile economic recovery. The resulting growth downturn would then be more severe than our central scenario.
– Bad surprise No.2 – 5%: a crash of the housing sector. There could be a combination of triggers: households turn out to be more vulnerable than expected to a housing price correction, and/or capital controls lose their potency. The impact on the whole economy would be catastrophic, and sharp renminbi depreciation could be one of collateral damages, especially the in case of capital flight.
Related links:
China approves controversial debt-for-equity programme – FT Oct 11
Let he who is not caught up in a global liquidity bubble… China property edition – FT Alphaville
China’s leaning towers – FT Alphaville
China’s still leaning towers – FT Alphaville
Snooping in the Bathroom to Assess Credit Risk in China — New York Times
