Is this China's building bubble?

Analysts say fears of collapse in China’s property market are overstated, though one ratings agency is concerned about bad debts on property loans

WHEN THE WIND whips up the dust in Beijing’s outskirts where demolition and rebuilding is proceeding at a frantic pace and cranes dot the skyline, you can sense the scale of China’s property market boom in your lungs.

At every traffic intersection, young hustlers pass out advertising leaflets for new housing developments. The property boom is the main topic of conversation over bowls of noodles and glasses of Maotai, a distilled sorghum drink, in the restaurants.

When it comes to nightmare scenarios, they don’t come much scarier than the one in which the property bubble in China goes pop and the world’s single biggest indicator collapses, bringing about the end of the greatest ever story of economic growth.

China’s property-market growth has a lot of bubble characteristics. By some reckoning, its biggest cities have seen prices rise by 50 per cent in the past two years.

House prices last year rose 26 per cent in Shanghai and 29 per cent in Chongqing, leading the government in Beijing to raise the minimum down payments on purchases of second homes and to tell local officials to set price targets on new properties.

Such figures are painfully familiar to many in Ireland, but analysts say that fears the bubble will burst may be overstated, at least for the time being, and that we can expect a gradual cooling of the market.

This is largely because the country still has some way to go in terms of urbanisation, and because the government appears to be prepared to intervene if the market starts to cool down too much, or if it starts to rise too quickly again.

After the sobering lessons seen in such countries as Ireland and Spain, a possible decline in the Chinese property market is a vision that can rob the sleep of bondholders across the world, derailing the fragile economic recovery, even as it gains momentum.

There are serious pressures at play, particularly as China is awash with cash right now and property is one of the few vehicles through which Chinese people can invest.

Bank deposits do not offer serious returns for investors keen to get a decent payback on their savings. The stock market is geared towards big institutions and most ordinary people are forbidden from investing abroad.

Plus there are speculators in the market who believe they are guaranteed a profit on their property investments, displaying the kind of hubris that saw wings badly burned in Ireland in recent years.

State companies that received lots of subsidies through a stimulus plan following the global economic crisis also have to look to property to keep the cash moving.

The importance of construction to the Chinese economy prompted the World Bank to describe the country’s real-estate sector as a “particular source of risk” to growth.

"Shocks to the property sector that would slow down construction significantly could have a large impact on the economy and on bank balance sheets," the Washington-based bank says in its China Quarterly Update, released in Beijing last month.

The World Bank has raised its growth forecast for the world’s fastest-growing major economy to 9.3 per cent this year due to faster-than-expected growth in the first quarter. It also raised its inflation estimate to 5 per cent from 4.7 per cent.

“A property downturn could affect the finances of local governments which do a lot of the infrastructure investment,” the bank says.

China experienced a lending boom in 2009 and 2010 and some analysts say the Beijing government may have to help banks at some stage, which would in turn affect the country’s credit profile. Last month the ratings agency Fitch downgraded the outlook on China’s long-term currency issuer default rating on concerns that bad debts on property loans and credit to local government financing vehicles risks could trigger another state-funded bailout.

“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,” says Andrew Colquhoun, head of Fitch’s Asia-Pacific sovereign ratings team.

Tensions between the underlying upward housing price pressure and the policy objective to contain price rises, interaction between the market and policy measures could lead to a more abrupt than planned downturn in the real estate market, the agency says.

Fitch said earlier this year that China was facing a 60 per cent risk of a banking crisis by the middle of 2013.

Mindful of that possibility, the government has intensified curbs on property investment, which seem to be paying off. Regulators last month ordered the banking sector to carry out more stress tests on property lending.

Meanwhile, premier Wen Jiabao has ordered local governments to cap increases in the prices of new homes after curbs on mortgage lending, higher down payments and limits on purchases failed to stem increases.

The government is studying rules to control developers’ profits to keep prices at a reasonable level, the China news service reported recently. China also plans to build 36 million units of social housing over the next five years.

While the Bank of England had only interest rates to protect markets there, China has a number of measures it can employ, and Beijing says they are paying off. There is not as much leverage in China as there was in the United Kingdom or Ireland.

Buyers are required to make a down payment of 40 per cent on a house they wish to purchase, and while prices are rising rapidly, so too are wages and salaries.

The price of new homes in Beijing rose 4.9 per cent in March from a year earlier, easing from a 6.8 per cent gain in February, while those in financial hub Shanghai climbed 1.7 per cent last month, down from 2.3 per cent growth in February.

Of the 70 cities monitored by the government, 67 cities posted gains, down from 68 in the first two months. Forty cities said in March they would restrict new home prices below annual economic and disposable per capita income growth or keep them steady following the central government’s measures to rein in housing values.

Since last month, the government has increased the banks’ reserve requirements to help cool inflation, and central bank governor Zhou Xiaochuan said monetary tightening would continue for “some time”.

Gareth Leather, economist at the Economist Intelligence Unit, says China is not experiencing a property bubble, despite the rise in house prices.

“We’re not saying there are no dangers in the short term. But the two main factors driving demand in China are different from those we saw in Ireland, Spain or the United States,” says Leather.

China is growing fast, but from a lower base. It is a highly populous, largely agricultural society that is being transformed at high speed into an urban society. By 2025, at least 220 Chinese cities are likely to have more than one million people.

Its urban population now is more than 540 million, which is more than the total population of the enlarged European Union, at about 490 million.

“China has lots of urbanisation, there are people moving to the cities in big numbers. And also there are people who want to move from old sub-standard housing to new housing. This is not what happened in Ireland, where the economic fundamentals were different,” says Leather.

There are plenty of bulls still around. Ronnie Chan, chairman of Hong Kong-based developer Hang Lung Properties, says strong demand from consumers and measures taken by the government would limit the chance that China’s property market will collapse.

Concerns over a real-estate bubble are unfounded, he told the Milken Institute Global Conference in Beverly Hills, California.

“People use the word [bubble] so loosely,” Chan said, adding that much of the existing housing in the country was substandard and would never be occupied as consumers demand higher quality homes.

“Those will be torn down, and a lot faster than you think,” said Chan, whose company is spending €3.45 billion on shopping malls and offices in five Chinese cities outside Shanghai.

All this investment in China is going to see trillions of dollars spent in the next few years, which will lead directly and indirectly to more than 50 per cent growth in demand for steel and strong demand of energy. This will place increased pressure on global markets for iron ore and oil.

Now there we can see another bubble in the making.