different, the Greek and the US public debt crises
threaten a return to the Great Recession of 2008.
The world is therefore savouring the reprieve provided
by their temporary resolution. But before that ephemeral
benefit could be enjoyed comes news of a potential
new global economic threat from an unsuspected source:
Its source lies in the boom in China's property market
over the last few years, which gathered substantial
momentum in the wake of the huge post-crisis stimulus
provided by the government to the economy. With a
significant share of that stimulus diverted to projects
that increased demand for real estate, price increases
have been so large that the spiral is now being identified
as a bubble.
Moreover, that bubble, some observers expect, is likely
to burst in the near future for three important reasons,
among others. The first is that the huge, speculative
investments made in this sector, especially in housing,
to cash in on the price spiral, has resulted in excess
supply in many markets, with housing properties lying
unsold and unoccupied.
The second is that even as the problem of oversupply
was beginning to be sensed in some quarters, the government
strengthened its efforts to rein in the housing boom,
partly to dampen speculation and prevent a bubble.
This was partly because grossly unaffordable housing
in the cities was making the government unpopular.
The government was also responding to evidence that
its huge stimulus package aimed at moderating the
effects of the global crisis was resulting in inflation
in the prices of real estate. In addition, the housing
and infrastructure boom was contributing to commodity
price inflation. To address these issues, it sought
to persuade banks to demand larger down payments from
clients, increase mortgage rates and restrict lending
for multiple housing investments.
Finally, there is the possibility that many who borrowed
to finance their housing and real estate purchases
may find it difficult to service their debt, since
interest rates are being raised to cool an overheated
economy. This could increase defaults and foreclosures,
bring more housing property to the market, as well
as limit additional demand.
Put together these developments are expected to result
in a supply-demand imbalance that would reduce house
price inflation and even trigger a fall in housing
prices. That, in turn, is expected to prick the speculative
bubble, leading to a bust in the form of a downward
spiral of real estate transactions and real estate
prices. The argument seems to be that since government
intervention is occurring a bit too late, it is contributing
to the onset of a crisis rather than stalling the
forces responsible for the build up to the crisis.
Since the prolonged property boom in China had generated
a fair share of sceptics who were expecting a bust,
this kind of speculation has found much favour. It
gained immediacy recently when housing price indices
based on prices in 70 cities rose by just 0.2 per
cent month-to-month in May and a lower 0.1 per cent
in June. On an annualised basis, housing price inflation
at 4.2 per cent was, in June, significantly below
the 6.4 per cent inflation in consumer prices. The
boom was indeed showing signs of tapering off. Was
this the prelude to a slump? As if to answer yes,
in April, rating agency Moody's downgraded China's
property sector from stable to negative. This both
reflected the mood among investors as well as served
as a signal to the more nervous among them.
All this has proved enough for a growing sense of
fear about China being the next epicentre of a crisis.
A collapse of the property boom in China would have
major repercussions domestically. To start with it
could dramatically slow growth, since GDP expansion
in China is driven substantially by investment, and
investment is driven largely by construction, especially
of housing and infrastructure.
The real estate market is also a major source of revenue
financing state expenditures at the provincial level.
The sale of land to developers is a major source of
revenues for provincial governments, which then put
the money to finance prestige infrastructure projects
aimed at attracting investments and winning political
attention. If the housing boom trips so will a lot
of this infrastructure spending.
Also, a substantial amount of this state spending
is financed by credit from the banking system, which
tends to view the real estate owned by local governments
as the implicit collateral that warrants huge lending.
There has been much concern in recent times about
the volume and quality of lending by the banks. The
first official overall estimate of local government
debt in China has placed it at Rmb10,700bn ($1,650bn),
or close to 30 per cent of GDP. Clearly, banks lending
to local governments have believed that these governments
will not default because they have enough resources
such as land to pay off the banks when faced with
a crunch. The confidence in such judgements seems
to be weakening, as reflected in the fact that some
investors are moving out of stocks of Chinese banks
that are not doing too well.
Fears about bank fragility also come from the direct
exposure of the banks to the housing market and to
real estate developers. Such exposure has been estimated
at 20 per cent of bank advances. If this market sours,
the hit on banks transmitted through provincial governments
will only be compounding a significant level of direct
damage. However remote that possibility, rating agency
Fitch has decided to save itself from possible ignominy
by warning Chinese banks of asset quality risk and
declaring that there is a more than reasonable chance
of a banking crisis by 2013.
Despite all this, China fears are by no means dominating
the headlines. There is much happening elsewhere,
in the US and Europe, to keep financial news enthusiasts
preoccupied. Further, there are other factors indicating
that China may not be anywhere near the brink of an
economic precipice. Stress tests, though unreliable
even in the best of times, have indicated banks can
easily handle a property market downturn. The average
Chinese household is not overly indebted with the
ratio of household debt to disposable income placed
at less than 50 per cent.
Moreover, house ownership even in urban, let alone
rural, China, is not very high relative to the population
of households. Urbanisation is set to accelerate,
with 300 million expected to move to the cities over
the next 20 years. With income rising and the government
encouraging private ownership of housing, demand is
likely to be sustained, even if not just for the luxury
housing that is the market that is possibly losing
some of its steam. Finally, housing construction is
unlikely to slow because of the government's decision
to make the provision of subsidised housing one of
its instruments to address the growing inequality
in the Chinese economy. The state plans to deliver
36 million subsidised houses over the next five years.
If it goes even a part of the way on delivering on
that promise, the construction boom would continue.
All this said, the fear of a housing and real estate
downturn in China is understandable. These sectors
directly and through the contribution they have made
to China's growth have also partly helped prop up
the global economy. They are the sectors that draw
huge quantities of steel, cement, household fittings
and accessories, the direct and indirect demand benefits
of which flow to the world market. China is not just
an exporter, but an importer as well. So everybody
is interested in a stable China. Fortunately for the
world, the state is still a major player in China.
And the signs are that it is responding to the danger
in more ways than one.