London’s Enodo Economics says that a mortgage-fuelled housing boom will make the impact of any future slumps in the property market far worse for the Chinese economy, and that Beijing should open its capital account in order to tame bottled-up speculative investment.
Writing for the Nikkei Asian Review, Diana Choyleva, chief economist of Enodo Economics, said that China’s housing market has undergone a major change in recent years, with more and more purchases financed using mortgages from banks in lieu of cash.
Total mortgage debt leaped 37% in 2016 to 24% of China’s GDP, as the country’s financial system matures and becomes more effective at channeling funds to households.
Enodo estimates that almost 70% of housing transactions were financed with a mortgage last year, double the share for 2013.
Choyleva notes, however, that regulation of mortgages and the housing market have yet to adequately mature, making the current credit-fueled boom a potential source of peril, particularly given the importance of the property sector to the Chinese economy.
“By some estimates, property development and ancillary industries together account for more than 20% of Chinese GDP,” writes Choyleva. “Their importance to the economy cannot be overstated.
“Any downturn in the housing market…would jeopardise the cash flow and debt-servicing ability of heavily-leveraged property developers, with potentially severe repercussions for the companies lenders and bondholders.”
In addition to risk for banks and investors, a property slump would also hit local government spending hard given its reliance upon land sales as a key source of revenue.
A fall in housing prices could also have dire repercussions for the broader economy by cratering consumer spending on the part of households, particularly given that property is the investment vehicle of choice for Chinese due to artificially suppressed deposit rates, capital controls and stock market volatility.
Speculative likely dominates home purchases
Enodo concurs with Chinese government view that much housing demand over the past two years has been driven by speculative rather than owner-occupiers, given that weak sales of home appliances would imply many properties are just sitting empty.
This view is further vindicated by a surge in peer-to-peer lending in 2015 and 2016, to put down home deposits that are 20% at a minimum in China, and run from 30 – 80% for second homes.
P2P lenders saw a tenfold rise in loans for down payments in 2015 alone after they start to explicitly target that market segment, while property developers are now offering collateral free loans for the full amount of down payments.
Beijing launched a crackdown on property speculation towards the end of last year, declaring that homes are “for living in, no speculation,” with measures including increases on down payments, curbs on home loan amounts, as well as increases in mortgage rates that are still ongoing.
Choyleva notes that while these regulatory measures are prudent, they pose a threat to confidence alongside the efforts of the China Banking Regulatory Commission to trim down the flourish shadow banking sector.
She advocates further liberalisation of China’s capital account as a solution to the fraught boom and bust cycle in the country’s property market, a measure which in her opinion is “more likely than not” within the next several years.
“The property market, like the stock market, is inevitably prone to periodic bouts of speculative frenzy because people have to keep most of their money inside China,” writes Choyleva. “Boom and busts would be less frequent if households could diversify their investments overseas.
“The prospects of China’s property market hinge therefore to a large extent on whether or not Beijing opens up the capital account.”