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2 China
reformers battle property inflation
addicts By Peter Lee
The People's Republic of China (PRC) is
experiencing a disturbing and somewhat unwelcome
result in its attempt to deal with its real estate
bubble: success.
Efforts to stop the flow
of loans and speculative energy into the real
estate sector have, to some extent, succeeded. The
carnival of greed and folly surrounding
construction of high-end residential and
commercial properties has abated thanks to a
combination of tightening loan requirements,
higher interest rates, limits on purchases of
second and third homes, and arm-twisting to get
local governments to build low-income housing.
Suppressing the real estate markets has
had unfavorable knock-on effects. The industries
that provide building materials,
appliances, and services
as well as finance and sell the product - which
according to estimates account for 40% of gross
domestic product (GDP) - have experienced a
fall-off in business. Local governments, which
rely inordinately on real estate development for
revenues, are predictably dismayed.
Unfortunately, the economic slowdown
accompanying the crackdown on real estate has been
exacerbated by pervasive woes in China's export
industries.
The eurozone simply isn't
pulling its weight, the recovery in the United
States is faltering, and the growth rate for
China's exports is dropping.
The PRC is
currently in the grips of a debate about what to
do about its looming economic crisis, and whether
the success in deflating the real estate market
should be sacrificed in favor of relaxing
regulations and sluicing a new wave of stimulus
money through the banks to be slurped up primarily
by the real estate hogs shouldering their way back
to the lending trough.
The key question is
what interest group and what ideology will drive
the government's response. In this context,
Premier Wen Jiabao's remarks during an inspection
tour in Jiangsu (perhaps consciously echoing Deng
Xiaoping's use of an inspection tour of south
China to publicize the importance of reform and
wrestle control of economic policy out of the
hands of the conservatives in 1992) acquire a
special importance.
Wen acknowledged that
the economy was experiencing "relatively large"
downward pressure and went on to say, as reported
by Bloomberg:
We must unswervingly continue to
implement all manner of controls in the property
market to allow prices to return to reasonable
levels. We cannot allow prices to rebound, or
all our efforts will come to naught.
From the comments of political and
economic reformers, it is clear that Wen was not
simply engaging in empty "on the one hand ... on
the other hand" rhetoric.
To the
reformers, fixing the real estate crisis is an
existential matter for the Chinese economic system
and the future of the country.
On his
Weibo blog, an influential economist in Jiangsu
province shared the concluding phrase from his
briefing to a meeting chaired by Premier Wen
during his visit: The Communist Party rose to
power by accomplishing an agrarian revolution; if
the land system breaks down, it will shake the
very foundation of the nation.
In this
environment, Wen's statement that real estate
prices would not be allowed to rebound was taken
as an important and vital political and economic
signal.
An economic journalist recorded
his dismay at the distortion of government
messaging on real estate that was occurring at the
local level: As the premier stressed on July 7,
macro-adjustment and - control of the real estate
market requires taking on a historical
responsibility ... Local policies or measures
launched in some regions to virtually back off on
real estate market adjustment and control and must
be promptly stopped and corrected. "Understanding
of his [the premier's] remarks is of great and
far-reaching significance for clarifying the
current trend in real estate and turning around
the chaotic situation in the market," the
journalist added.
Indeed, there are large
and influential constituencies that want the real
estate market to reinflate: 1. Planners who
want to kick the can down the road and sustain
economic activity until a global recovery revives
the export market; 2. Local governments, who
tiptoe along the red ledge of fiscal disaster and
look to real estate-related activity as their
economic salvation; 3. Real estate companies,
who understandably prefer a yeasty, growing market
to financial ruin; 4. State-owned enterprises,
which have exploited their preferential access to
credit to sluice money into real estate
development; 5. State-owned banks, which carry
a huge amount of real estate risk on their books
as collateral, and also lack the skills and
imagination to lend beyond their traditional
circle of real estate-centric governments and
enterprises.
On the other side of the
fence are reformists and significant elements in
the central government who would like to address
and control the problem, instead of standing back
and letting the problem increase in size over the
next few years until it threatens the survival of
the economic system and the state.
The
central problem for the reformers seems to be that
the Chinese economic and financial system is still
relatively rickety, equity and bond markets have
not emerged as significant alternatives to bank
credit, and there are not a lot of good, mature
alternatives to reliance on a broken bank and real
estate model when it comes to delivering stimulus
- or even just cash - to the economy.
State banks have emerged as little more
than reliable inflation pumps. It seems that, even
as the central government is trying to deflate the
real estate bubble, all banks know how to do is
feed it by business as usual lending to the usual
suspects.
When the government relaxes
lending curbs, the banks pour money into the hands
of the people they know best: SOEs, real estate
companies, and local governments all eager to
inflate the real estate bubble. This problematic
state of affairs has, until recently, been
rewarded with a highly favorable fixed spread of
3% between borrowing and lending.
China's
banking system is derided as an ATM for
unproductive, government-directed investment. When
the easy-money punch bowl goes dry and the economy
goes south, the banks' lazy bad bets come back to
haunt them. Or, in bank-speak:
The amount
and ratio of non-performing loans (NPL) in the
banking sector is increasing this year after
dropping for years. The NPL ratio at some major
commercial banks has hit 2%. Analysts blame the
increase on the economic slowdown and a previous
surge in credit. Some say it reflects flaws in
corporate governance structures and internal risk
controls of commercial banks. [2]
For the
reformers, the designated saviors of the Chinese
economy are reform of the financial system;
promoting consumers and private investors as a
counterweight to the economic dominance of the
SOEs (state-owned enterprises); and supporting
entrepreneurs - aka small and medium-sized
enterprises (SMEs) in order to bring competition,
innovation, and market discipline to the economy
and the financial sector.
The reformers
have introduced a broad range of policies in order
to foster these groups and goals.
Taking
aim at the banking sector, the Chinese government
is looking to private (Chinese) investment in new
banks to inject some life in the sector and
provide credit to smaller enterprises.
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