Tag: China

China Can Cope With US Tariffs, But Trade Risks Rising

The US government’s proposal to impose tariffs on USD50 billion-USD60 billion worth of imports from China is unlikely to have a significant impact on the Chinese or global economy, says Fitch Ratings.

The risk that piecemeal protectionist measures escalate into a more damaging trade war has risen in recent months, but China’s measured response so far and US indications of openness to negotiation suggest this scenario should still be avoided.

The US administration has proposed the tariffs in response to what it considers to be unfair Chinese trade policies that have led to the acquisition of US technologies – invoking the authority provided by Section 301 of the US Trade Act. Aerospace, information and communication technology, and machinery will be targeted, with details due within the next two weeks. The administration will also consider measures to block Chinese acquisition of US technology through M&A and press the World Trade Organization to examine China’s technology licensing practices.

USD60 billion is equivalent to around 2.5% of China’s total merchandise exports, or 0.5% of its GDP, but the impact of the tariffs on the Chinese economy would be much smaller. Some of these goods will still end up going to the US, given the lack of substitutes, while others could be diverted to different markets. Moreover, the domestic value-added content of China’s exports is typically only around two-thirds, or less than one-half in the case of ICT goods, which contain a high proportion of imported inputs. Overall, we would not expect these tariffs to create a drag on Chinese GDP growth of much more than 0.1 percentage point this year.

The bigger risk is that the US eventually imposes across-the-board tariffs on China, either because its bilateral trade deficit with China stays large or in the context of an escalating trade war between the two countries. The US accounts for almost one-fifth of China’s total exports, equivalent to 3.6% of Chinese GDP, so broader tariffs could have a sizeable impact on China’s economy, and would have knock-on effects for the supply chain across the rest of Asia. A China-US trade war would also undermine global investor sentiment.

This more severe scenario cannot be ruled out, but we still expect new policies, either from the US or China in retaliation, to continue to fall under sector-specific measures. China has announced its own tariffs targeting USD3 billion worth of US agricultural goods in response to previous US tariffs on steel and aluminium, but Premier Li Keqiang has stated that “a trade war does no good to either side”. Meanwhile, US President Donald Trump has stated that the US and China are in negotiations. In that respect, the 30-day consultation period following the release of US tariff details should temper the prospect of immediate escalation and could provide time for a compromise to be reached.

A more challenging external environment could add to the risk of Chinese policymakers falling back on credit-fuelled stimulus, which would also be a major setback to the deleveraging agenda. Strong external demand was a key factor behind the outperformance of China’s economy last year, which allowed the authorities to focus on addressing financial risks without jeopardising GDP growth targets.

China’s new central bank governor will have to deal with massive debt and an ambitious economic agenda

From The Conversation.

The Chinese government has appointed a new head of its central bank. Yi Gang, currently the deputy governor of the People’s Bank of China, will take over the leadership from Zhou Xiaochuan, who had been in the position since 2002.

As China’s central bank oversees the stability of the world’s second-largest economy and the world’s largest pile of foreign reserves, this is a change the global economy is watching closely.

A US-trained economist, Yi received his doctorate in economics from the University of Illinois in 1986. He was a professor at Peking University in China following various academic positions in the US, before joining China’s central bank in 1997. Yi is known in academia for his expertise on inflation and price instability.

Yi developed his technocratic career exclusively within the headquarters of the central bank, taking up various leading positions in areas of monetary policy, exchange rate policy, and foreign reserve management. He then became the right-hand man of Zhou, who dominated Beijing’s economic policy-making for a record 15 years.

However Yi’s governorship came as a surprise, given the widely circulated rumours of other powerful contenders, such as Liu He, now announced as a vice premier of China, and Guo Shuqing, the chairman of China Banking Regulatory Commission.

But the appointment makes sense if the reshuffle of president Xi Jinping’s economic team is taken into account, as like-minded liberals lining up in key positions. Yi will actually work directly under Liu, who also trained in the US, ensuring that the government keeps in close consultation with the central bank while the bank does not stray politically.

Problems the new governor will have to confront

Now that the jockeying for the top position at the central bank is over, the new governor is bound to carry on Zhou’s liberal legacy and to tackle some of the more daunting challenges the Chinese economy faces.

First up is the need to further strengthen the central bank, which has been given extra duties in financial legislation and regulation in the latest round of administrative streamlining announced at the People’s Congress. After all, the authority of the central bank in government circles over the last two decades has largely hinged on the bank playing an indispensable role in providing professional expertise.

Yi will also work to defuse the debt bomb that has been lurking behind a series of alarming statistics of the Chinese economy. In particular, China’s total debt has almost doubled between 2008 and mid-2017, to 256% of GDP as the economy slowed down from double-digit growth to a mere 6%.

A distressed financial system could trigger a systemic economic collapse. To reign in this possibility, Yi will have to work closely with authorities in the State Council, China’s cabinet, to contain the risks to a manageable scale.

The bank will have to walk a fine line here. It must contain the shadow banking sector, which is largely beyond the radar of the authorities. At the same time it has to make sure such tightening does not choke financial innovations embodied by the burgeoning internet finance and fintech.

Equally, if not more important, the financial reforms must be taken to facilitate China’s grand economic transition. In the short to medium term, this entails a further aligning of China’s interest rates to China’s market levels.

They also need to bring its exchange rates in line with international market levels, open its financial markets in a gradual and orderly fashion, and push for the use of the Chinese currency in the global market. This is an ambitious project initiated by Zhou with the goal of seeing the renminbi’s international status on par with the greenback.

A more open and liberal financial system in China is of course good news for the world economy as well because central banks need to work together to address increasingly divergent policy priorities among advanced and emerging economies.

Whether or not Yi becomes the next “Mr RMB” (as Zhou is often dubbed), he needs to be the “Dr Reformer” at this critical stage of both the Chinese and global economy.

Author: Hui Feng, Future Fellow and Senior Research Fellow, Griffith University

China’s Thrift, and What to Do About It

From The IMFBlog.

What makes China’s citizens so thrifty, and why does that matter for China and the rest of the world? The country’s saving rate, at 46 percent of GDP, is among the world’s highest. Households account for about half of savings, with corporations and the government making up the rest.

Saving is good, right? Up to a point. But too much saving by individuals can be bad for society. That’s because the flip side of high savings is low consumption and low household welfare. High savings can also fuel excessive investment, resulting in a buildup of debt in China. And because people in China save so much, they buy fewer imported goods than they sell abroad. That contributes to global imbalances, according to a recent IMF paper, China’s High Savings: Drivers, Prospects, and Policies. The country’s authorities are aware of the issue and are taking steps to address it.

China’s saving rate started to soar in the late 1970s. A look at some of the causes of the increase points to some potential remedies.

Demographics explain about half the increase in saving, the Chart of the Week shows. China’s average family size dropped dramatically after the introduction of the “one child” policy. That influenced household budgets in two ways. Parents spent less money raising their children. At the same time, because children were traditionally a source of support in old age, having fewer children prompted parents to save more for retirement.

Greater income inequality, resulting from China’s transition to a more market-driven economy, is also a big contributor. A wider gap between rich and poor increases saving because the wealthy spend a smaller proportion of their income on necessities and put more money in the bank.

Economic reform has boosted saving in other ways. More Chinese now live in their own homes, as opposed to housing provided by state-owned enterprises. So they must save for a down payment and for mortgage payments. (Household debt, while still low, has risen rapidly in recent years, linked largely to asset price speculation.) And a decline in government spending on social services during the economic transition in the 1980s and 90s has meant that Chinese must save more for retirement or to pay for health care.

There are several things the government can do to encourage more spending:

  • Make the income tax more progressive and family friendly;
  • Spend more on health care, pensions and education;
  • Spend more on assistance to the poor, which would reduce income inequality.

Of course, China will need more revenue to pay for all of this. One answer would be to increase the dividends paid by state owned enterprises. Another would be to transfer shares of these firms to social security funds. With the right policies, China can encourage spending while avoiding the fate predicted by Confucius: “He who does not economize must agonize.”

Chinese account for one-third of Australian development site sales in 2017: Report

From The Real Estate Conversation.

A new report from Knight Frank claims that in 2017, one-third of Australian residential development sites were sold to Chinese investors and developers.

In total, site sales to Chinese investors and developers equated to $2.02 billion, according to the report ‘Chinese Developers in Australia – Market Insight 2018’.

The report has been released to coincide with Chinese New Year, which this year is on Friday 16 February, 2018.

Knight Frank’s head of residential research, Australia, Michelle Ciesielski said, “Chinese developers have continued to dominate foreign investment in residential development sites across Australia. Many are now well-established in the local market.”

The share of sales to Chinese buyers has tripled since 2013, but decreased from the 38 per cent recorded in 2016, she said.

Source: Knight Frank Research.

Tighter regulation in both Australia and China has not dampened Chinese interest in Australian real estate

“Sustained developer interest in the Australian market has come in spite of government efforts in both Australia and China to tighten credit conditions as they relate to residential investment and development,” said Ciesielski.

Related content: What do China’s new capital controls mean for Australian real estate?

“In Australia, the Australian Prudential Regulatory Authority has encouraged local financial institutions to impose stricter controls, while in China the government has attempted to moderate capital outflow with China’s Central Bank imposing new rules for companies which make yuan-denominated loans to overseas entities.

“However, in mid-2017, this was relaxed somewhat – resulting in a boost to market confidence.” said Ciesielski.

Melbourne received the highest proportion of Chinese buyers of development sites

The level of Chinese investment in residential development sites varied from state to state:

  • in Victoria, 38.7 per cent of residential site sales were to Chinese buyers
  • in New South Wales, 35.6 per cent of residential site sales were to Chinese buyers, and
  • in Queensland, Chinese buyers comprised 7.4 per cent of total residential site sale volumes.

Ciesielski said Melbourne was the most popular city for Chinese investors because it has sustained population growth, strong residential capital gains, and relatively low total vacancy rates.

“Many developers consider that Melbourne offers better relative value when compared to Sydney,” she said.

Chinese developers are shifting their focus to lower density developments

The report shows that Chinese developers and investors are increasingly focused on lower density developments in Australia, with 29 per cent of all sites purchased suited to low density, up from two per cent in 2013.

Source: Knight Frank Research.

Knight Frank’s head of Asian markets, Australia, Dominic Ong said, “As Chinese developers gain experience in higher-density projects across the major cities, there has been diversification in many of their portfolios to include medium and lower-density sites.

“These lower-density projects have also become more popular with local developers – especially in NSW, with the draft Medium Density Design Guide being released, identifying the ‘missing middle’ to encourage more low-rise, medium-density housing to be built.

“This type of project also tends to have less hurdles with the imposed tighter lending restrictions, and overall, lowers the delivery risk to the developer,” said Ong.

Chinese developers are buying larger plots

Ciesielski said that because Chinese buyers are shifting to lower-density developments, the size of the sites they are buying is larger.

“In 2017, the average site purchased was 21,785 square metres, increasing three-fold since 2013,” she said.

Source: Knight Frank Research.

“It’s expected lengthier due diligence will be carried out for those now established in the local market, and for new developers coming into Australia, transactions will be reliant on the ability to transfer their funds,” concluded Ciesielski.

China implements Basel Committee framework for controlling large exposures, curtailing bank risk

From Moody’s.

Last Friday, the China Banking Regulatory Commission published for public comment a draft regulation of commercial banks’ large exposure management in accordance with the Basel Committee on Banking Supervision’s framework. The draft regulation is credit positive for banks because it will quantifiably curtail the shadow-banking practice of investing in structured products without risk-managing the underlying exposures and will limit the concentration risk in traditional non-structured loan portfolios.

For the first time, regulators are introducing binding and quantifiable metrics to implement the look-through approach when measuring credit exposures of investments in structured products, as emphasized in a series of recent steps to tighten shadow banking activities.  A bank must aggregate unidentified counterparty risk in a structured investment’s underlying assets as if the credit exposures relate to a single counterparty (i.e., the unknown client) and reduce that aggregate exposure to below 15% of the bank’s Tier 1 capital by the end of 2018. Any investment in structured products above the capped amount must identify counterparty risks associated with underlying assets so that investing banks can manage the risks accordingly.

The draft regulation’s measure of the unknown client limit will discipline banks’ implementation of the look-through approach to their investment portfolio to address opaque bank investment categories such as “investment in loans and receivables” that have been originated by other financial institutions. For the 16 listed banks that we rate, which account for more than 70% of the country’s commercial banking-sector assets, total investment in loans and receivables was slightly more than 100% of Tier 1 capital as of 30 June 2017. This implies a forced look-through approach will be applied to more than 85% of this segment of banks’ investment portfolios (see exhibit).

For the concentration risk in traditional non-structured loan portfolios, the draft regulation reiterates the current rule limiting a bank’s loans to a single customer to 10% of the bank’s Tier 1 capital, and extends the limit to include non-loan credit exposure to a single customer at 15% of Tier 1 capital. For a group of connected customers, either through corporate governance or through economic dependence, the draft regulation caps a bank’s total credit exposure at 20% of Tier 1 capital.

For a group of connected financial-institution counterparties, the draft regulation caps a bank’s total credit exposure at 100% of Tier 1 capital by 30 June 2019 and steadily lowers the cap to 25% by the end of 2021. In the case of credit exposures between global systemically important banks (G-SIBs), the cap is 15% of Tier 1 capital within a year of the bank’s designation as a G-SIB.

China’s Tightens Regulation of Internet-based Consumer Finance

Last Friday, the People’s Bank of China and China Banking Regulatory Commission issued a regulation to rectify excesses in internet-based consumer finance says Moody’s.

The regulation is credit positive for banks because it will help prevent a rapid increase in consumer leverage, strengthen banks’ risk management and limit disorderly competition. Exhibit 1 shows that outstanding internet-based person-to-person (P2P) loans were RMB1.2 trillion ($181.8 billion) at November 2017, 13.4x the amount three years earlier and far outstripping the growth of traditional micro-credit companies (MCCs).

 

With immediate effect, the regulation stops any unlicensed firms or individuals from making loans. The regulation also temporarily bans internet-based platform companies from making general-purpose unsecured consumer loans and permanently bans loans to finance down payments of housing purchases and loans for purchases of stocks and futures. The permanent ban on affected loans is in line with the authorities’ policy priority of deleveraging the financial system and the real economy.

The regulation curtails funding available to all MCCs, either online platforms or offline traditional entities. MCCs can no longer sell their loans through internet-based or local trading platforms and MCCs must consolidate on their balance sheets loans that have been sold or securitized.

P2P platform companies are particularly prone to liquidity and solvency stresses, as shown in Exhibit 2. The improved risk management of MCCs will help improve the asset quality of banks that lend to MCCs, which would reduce the systemic transmission of risks. The regulation prohibits banks from investing either their on-balance-sheet funds or off-balance-sheet wealth-management products in structured products with underlying assets sourced from the affected loans.

In addition, the regulation prohibits banks’ outsourcing of credit underwriting and risk management functions to internet-based credit service platforms. Banks must validate consumer credit information against centralized databases maintained by the People’s Bank of China and National Internet Finance Association of China. This will discipline banks to strengthen their internal process of managing the use of consumer credit information in originating consumer loans.

Larger banks are likely to benefit most because their brand recognition is more attractive to customers as the regulation reforms the sector. For the 16 listed banks, which account for more than 70% of the country’s commercial banking-sector assets, new retail loans were 54.3% of the increase of the total loan balance in the first half of 2017.

 

Four Chinese e-commerce businesses with their eyes on Australia

From Smart Company.

It’s been a big year for global players eyeing off Australian’s retail sector, but if you think Amazon is the only giant force changing the local market, you’re not looking hard enough.

As shoppers stare down the end of 2017, three of the biggest players in China’s digital retail space are executing long-term strategies in Australia, while others have their sights set on capturing Chinese shoppers arriving in Australia in search of locally made products.

Here are four operators that could present big opportunities for local SMEs wanting to connect with the Chinese market — and what you need to know about the plans they already have underway here.

Alibaba

Global revenue: $US23 billion ($30.28 billion) in 2017.

Founded by: Jack Ma.

Australian operations: Alibaba’s Tmall sales platform has been a selling opportunity for local brands like vitamins producer Blackmores for years, but it wasn’t until 2017 that a more formal long-term relationship was established between the e-commerce giant and the Australian market, when Prime Minister Malcolm Turnbull signed a commitment with Alibaba founder Jack Ma to work together to bring more local sellers onto the platform.

At the time, Australia was in the top five nations selling through Alibaba’s platforms. In February, the company launched an Australian and New Zealand headquarters in Melbourne, with local operations headed up by Maggie Zhou, who has been with the company for more than 15 years.

Opportunities for SMEs: Alibaba has been engaging with Australian retailers throughout the year, holding a variety of seller summits and e-commerce expos, including taking 500 businesses through best practice steps for selling through the platform at a two-day event run in October. Alibaba says there are currently 1300 Australian companies and 400 New Zealand companies selling through the platform.

Maggie Zhou said earlier this year that establishing an Australian office was only the very first step for the business in Australia.

“Longer term, Alibaba Group’s vision for the ANZ region is to build the entire operating infrastructure needed to enable local businesses to expand globally,” she said in February.

JD.com

Global revenue: $US37.5 billion ($49.35 billion) in 2016.

Founded by: Liu Qiangdong, also known as Richard Liu

Australian operations: JD.com claims to be the largest e-commerce retailer in China by revenue, and courts more than 266 million active customers through “JD Mall” across all categories, including fresh food. Earlier in 2017, JD.com management visited Australia with an announcement it was searching for more than 100 Australian data scientists to develop artificial intelligence retail technologies for the business. At the time, head of digital marketing Paul Yan told The Australian “Australia is a very important market for us”.

In November, the company told Inside Retail it is undertaking more local recruitment with a long-term plan of opening up an Australian headquarters in the neat future.

Opportunities for SMEs: Inside Retail reports the company’s president of international corporate affairs says “thousands” of Australian brands already work with JD to sell through its platforms. In 2015, JD launched an “Australian Mall” product, allowing Chinese shoppers to peruse Australian-made offerings. In March, founder Richard Liu visited Australia to put the call out to local retailers, asking them to start the conversation about selling through JD.

“Even with the Chinese economy slowing slightly in recent years, the retail sector, especially online, has continued to see outstanding growth,” he told The Australian. 

VIP.com

Global revenue: $US8.15 billion ($10.98 billion) for parent company vipshop in 2016. 

Founded by: Eric Ya Shen and Arthur Xiaobo Hong

Australian operations: VIP.com has announced plans to procure more than $500 million of Australian goods in the 2018 financial year as the discount retailer works towards opening a Sydney distribution centre this year. The company’s head of global buying, Hillary Wang, said in a statement last week that the retailer is aiming to become the number one retail platform in China, with Australia being a “very strong market” from which to draw sellers in the future.

Opportunities for SMEs: The company says it is rapidly increasing its order volume quarter on quarter, with the most recent figures of 74 million transactions over three months amounting to a 23% increase on the 60 million orders it saw a year ago. The platform is more focused on female shoppers than others in this space, with 80% of its shoppers being female. VIP says it is focused on pulling more Australian retailers onto its platforms, searching for brands “rich in history, made with the best ingredients to the highest standards”, Wang says.

AuMake

Revenue: $1.23 million in 2016. 

Founded by: Jiahua Zhou

Australian operations: This Australian-founded, ASX-listed retailer might not yet be at the billion-dollar sales volume of other Chinese retail brands, but it’s still an important one for local SMEs to take note of. The business aims to capture the Chinese “daigou” market by connecting shoppers with locally made products. The business has plans to expand an e-commerce offering and capture a market of Chinese tourists and visitors by selling products through bricks-and-mortar stores within Australia.

Opportunities for SMEs: In a company update released yesterday, chairman Keong Chan signaled a focus on connecting with more local suppliers and brands. The business has secured a strategic alliance with Australian Made, which it says will provide it with access to 2700 local suppliers involved with the Australian Made organisation. The company has also secured the Jumbuck and UGG trademarks to sell these products through AuMake stores.

“We believe the Chinese tourist market has the potential to be equal to the daigou market in terms of brand promotion and raw purchasing power,” Chan said yesterday.

Chinese Homebuilder Outlook Stable, but Market to Cool

China’s housing market is likely to continue to cool in 2018, with sales growth set to slow across most of the country and house prices likely to stay relatively flat, says Fitch Ratings.

However, the authorities have considerable policy flexibility to support housing demand, which limits the risk of a market downturn. We therefore maintain a stable sector outlook for Chinese homebuilders.

The Chinese government has imposed tougher rules on home purchases and minimum loan deposits in higher-tier cities since October 2016 to dampen speculation. We do not expect further tightening in 2018, except perhaps in some lower-tier cities in strong economic regions that could see price increases. Most of the existing restrictions are likely to remain in place, but policies could be adjusted to encourage homeownership for first-time homebuyers or to attract skilled labour migration in some cities where house prices have stabilised.

The curbs have had a clear impact on the market, reining in house price inflation, tempering home sales growth and encouraging destocking. We expect them to limit any gains in house prices in 2018. Contracted sales growth is likely to slow for most homebuilders, and we forecast that overall housing sales will decelerate to 5%, from 10.9% yoy on a trailing 12-months contracted sales at end-October 2017. The destocking cycle could, however, begin to reverse, as some companies now only have land bank reserves for two to three years of development.

A major house price correction is unlikely, given that the authorities directly control many aspects of the housing and mortgage markets. Moreover, the restrictions in higher-tier cities, which have seen the strongest price gains in recent years, have led to considerable pent-up demand that could be released if policy is relaxed.

Homebuilders’ EBITDA margins could begin to narrow in 2018 and 2019 as homebuilders start to work through their higher-cost inventory in a market where prices are under pressure from government controls. Leverage is likely to remain relatively stable over the next two years, with net debt/adjusted inventory averaging 40%-43% among Fitch-rated homebuilders. Cash flow generation is also likely to remain strong.

We maintain a stable sector outlook on commercial property. Mall traffic in higher-tier cities is suffering from strong saturation and competition from e-commerce, with only mature malls in prime locations performing well. We believe these first-tier city malls will achieve low single-digit yoy rental growth in 2018, similar to 2017. However, malls of established operators in less-saturated lower-tier cities are seeing strong traffic growth.

Grade A office space in most first-tier cities is likely to remain broadly stable, and we expect the vacancy rate to stay below 15%. However, office assets in Guangzhou and Shenzen, as well as in lower-tier cities, have higher vacancy rates and could be affected by an increase in supply in 2018.

China to tighten regulations on financial firms’ shareholding

From Moodys

On 16 November, the China Banking Regulatory Commission published for public comment a draft regulation on commercial banks’ shareholding. The draft regulation raises the bar for investor qualification, demands the long-term commitment of significant shareholders’ (those owning a 5% or greater stake) investment, and requires annual disclosures of significant shareholders and related parties. The proposed regulation is credit positive for China’s financial firms because it will limit the systemic transmission of financial risks, improve the quality of the firms’ capital and strengthen their corporate governance.

The draft regulation will serve as a benchmark for regulating non-bank financial institutions including rural credit cooperatives, trust companies, financial leasing companies, automobile and consumer finance companies, and financial asset management companies, which are a type of specialist firm that works out nonperforming financial assets. More stringent investor qualifications include a ban on leveraged acquisition of shares, in line with the authorities’ policy priority of deleveraging the financial system and the real economy. In addition, the draft regulation will limit system interconnectedness by restricting any investor from becoming a significant shareholder of more than two banks or a majority shareholder of more than one bank.

The draft regulation also raises the entry barrier for significant shareholders by setting up a prior-approval process to screen out investors that have overdue bank debts or outstanding court judgments against defaults. Investment pools such as funds, insurance asset-management plans or trust plans cannot own more than 5% of a bank if they are ultimately controlled by a single entity. The higher barrier will diversify the investor base for banks and reduce system interconnectedness. The tighter ownership rules are particularly relevant for rural commercial lenders, which are transforming themselves to commercial banks from mutual institutions of credit cooperatives (see Exhibit 1).

In the banking regulator’s view, there is abundant capital to invest in bank shares, attracted by the sector’s higher profitability. As Exhibit 2 shows, rural commercial banks have had profitability and capital metrics second only to China’s big five banks.

 

Securing quality capital will improve banks’ creditworthiness. The draft regulation will improve the quality of capital that banks receive from significant shareholders by annually certifying a shareholder’s ability to inject capital into investee firms in times of need. The draft regulation also requires a five-year lockup period of significant shareholders’ investment to protect banks’ ability to create long-term value.

Additionally, the draft regulation tightens the enforcement of existing rules on connected-party transactions by expanding the scope of the rule. Emphasizing a “see-through” principle to improve disclosure on the ultimate beneficiaries of shareholding, the draft regulation specifies connected parties include investors’ controlling shareholder, actual controlling entity, affiliated entities, entities acting in concert and ultimate beneficiaries.

Assessing China’s Residential Real Estate Market

The IMF just published a working paper examining real estate in China.

After a temporary slowdown in 2014-2015 China’s real estate market rebounded sharply in 2016. As signs of overheating emerged, the government turned to tighten real estate markets through a range of macroprudential and administrative measures. Many empirical studies point out that the house price surge is driven by fundamentals, while others consider the pickup of real estate activity is unsustainable. This paper uses city-level real estate data to estimate the range of overvaluation of real estate markets across city-tiers, and assesses the main risks of a real estate slowdown and its impact on economic growth and financial stability.

Real estate has been a key engine of China’s rapid growth in the past decades. Real estate investment grew rapidly from about 4 percent of GDP in 1997 to the peak of 15 percent of GDP in 2014, with residential investment accounting for over two thirds of the total real estate investment.

Bank lending to the sector makes up 25 percent of total bank loans, about half of all new loans in 2016, and banks’ increasing exposures to real estate, including through property developers and household mortgages, may pose financial stability concerns. Real estate also has strong linkages to upstream and downstream industries (about a quarter of GDP is real-estate related).2 In addition, land sales are a key source of local public finance, accounting for about 30 percent of local government revenue in 2016, while general government net spending financed by land sales is about 9 percent of the headline revenue in 2016. There has been a rapid expansion of government subsidies on social housing, consisting of nearly 6 million apartment units in 2015-2017.

Real estate markets vary significantly in China because of its large economic size, economic and social diversity, and fragmented local government policies. The real estate cycles tend to be more pronounced in top-tier cities in terms of price volatility, but they account for a small fraction of real estate inventory and investment.  Smaller cities constitute over half of residential real estate investment, but the price increase on average was much lower during 2013-16.

Distortions render China’s property market susceptible to both price misalignment and overbuilding. On the supply side, the market is distorted by local governments’ control over land supply and their reliance on land sales to finance spending. On the demand side, the market is prone to overvaluation—housing is attractive as an investment instrument given a history of robust capital gains, high savings, low real deposit interest rates, a lack of alternative financial assets, as well as capital account restrictions.

The government has closely monitored real estate activity given its importance in the economy. Policies are highly decentralized, with local governments (often with local branches of the financial regulators) deciding land sale and infrastructure development, granting construction and sales permits to developers, and setting purchases restrictions. The central government and financial regulators can also affect the housing market through financing conditions and macro-prudential tools for mortgage lending.

If house prices rise further beyond “fundamental” levels and the bubble expands to smaller cities, it would increase the likelihood and costs of a sharp correction, which would weaken growth, undermine financial stability, reduce local government spending room, and spur capital outflows. Empirical analysis suggests that the increasing intensity of macroprudential policies tailored to local conditions is appropriate. The government should expand its toolkit to include additional macroprudential measures and push forward reforms to address the fundamental imbalances in the residential housing market.

Note: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.