Can China Reflate the Housing Market?

Nicholas Borst (Federal Reserve Bank of San Francisco)



China’s extraordinary real estate boom may finally be over. Multiple indicators suggest that China is on the precipice of a significant market correction. Prices are down in more than half of the 70 cities surveyed by National Bureau of Statistics. Beyond price data (which is subject to some skepticism), residential floor space under construction, residential real estate investment, total floor space starts, and residential floor space sales all show declines.

Looking at the graph above, you can see that last time there was a falloff in activity of this magnitude was in 2008 when policies restricting real estate investment began to take hold and the financial crisis brought everything to a halt. The real estate sector recovered quickly in 2009 when the government took off restrictive measures and stimulated the housing market as a way to promote economic recovery.

With GDP numbers from last quarter coming in low, perhaps lower than China’s leaders desired, there is a lot of talk about taking some of the pressure off the housing market. Should China be trying to reflate the housing market? If they try to reflate will they be successful?

If Chinese policymakers decide to boost the property market there are several different policy options at their disposal:

1. Reinstate benchmark rate discounts: Typically homebuyers have been offered a borrowing rate that is lower than the benchmark rate. This important concession was removed during this and the previous round of tightening. The discount rate for first-time homebuyers was removed and rates for investment properties were raised to penalty levels (above the benchmark rate). Reinstating these discount rates is already underway as several banks are now offering first-time homebuyers a 15 percent discount.

2. Remove restrictions on non-residents: In an effort to tamp down on speculation, Chinese cities across the country have put restrictions on foreigners and non-residents buying homes. Removing these restrictions would boost demand for housing.

3. Boost social housing spending: The Chinese government will spend billions of renminbi over the next several years to build a planned 35 million social housing units. While this amount by itself is not enough to prop-up demand, further increases in social housing spending could take some of the sting out of a real estate correction.

4. Alter taxes that affect housing demand: There are several different taxes that directly impact homebuyers, including various land use taxes, the sales tax on property transactions, and a traditional property tax in Chongqing and Shanghai. Cutting these could bring back buyers to the property market and encourage more investment.

5. Remove construction restrictions: In an effort to force developers to build more affordable housing, the central and local governments have put a variety of restrictions on the size and density of houses than can be built. Ending these restrictions would boost developers’ profitability and increase supply.

However, there are now enough countervailing forces at work that the traditional policy tools outlined above may not be enough to bring the housing market back to life. First, over the past couple of years there has been a tremendous shift in housing price expectations. According to the People’s Bank of China, the percentage of people who think housing prices will continue to rise has fallen from 46 percent in Q4 2009 to less than 18 percent in Q1 2012. As more and more people become convinced housing is no longer a sure bet, they may be less eager to channel their savings into real estate. Second, household debt as a percent of disposable income has doubled since 2003, increasing from 27 percent to 54 percent. Households are more leveraged than before and may decide to not increase the share of their assets held in housing. Third, banks are much more exposed to the property market than they were in the early 2000s, with real estate loans now accounting for 20 percent of the total loan book and equivalent to 200 percent of bank capital. Banks may be close to reaching a tipping point where they decide they need to limit their exposure the property market.

Perhaps more importantly, should China even be trying to reflate the housing market? Prices still are unaffordable given incomes in China and real estate investment as a share of GDP is worryingly high, much higher in fact than the United States at the peak of its housing boom. For economic growth to be on a more sustainable path, property investment needs to decline to lower levels. The trick for Chinese policymakers will be to continue to let the housing market adjust to more normal levels without halting economic growth altogether. Boosting consumption to offset the drag from lower investment will be key to this process. If the savings rate stays high while financial repression is still in place, savings may flow out of the property market and into a new speculative bubble somewhere else in the economy.

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