Body
Housing prices in China may have stalled in the short-term, but the long-term drivers of the property bubble are still in place.
Official statistics show that the tightening measures introduced by the government early last year are beginning to take the steam out of housing price increases. According to NBS data for 70 cities across China, housing prices have been flat over recent months.
The graph below shows the median house price increase on a month-over-month basis.
Reports are spreading that many housing markets in the tier-one cities (Beijing, Shanghai, etc.) are upside down (倒挂).
The term upside down refers to previously-owned apartments (二手房) being priced higher than equivalent new units. Given the strong predilection among Chinese consumers for owning new apartments, an upside down housing market indicates that there are major price distortions at work.
The forces behind falling prices for new units are fairly clear. Many property developers are facing new financing constraints and lower profits as a result of government policies to deflate the housing bubble. As a result, property developers are aggressively cutting prices on new units to clear out inventory. They are doing so in an effort to improve their cash flow and in some cases to avoid bankruptcy.
Why previously-owned apartments haven't followed suit is a little more complex. A series of new restrictions and taxes have made selling apartments more difficult and less profitable.
While these factors are important, the key driver of the new/old unit price discrepancy is China's restrictive financial system. As long as financial repression is in place (see Nick Lardy's paper on the subject) money will continue to flow into housing.
Financial repression makes homeowners reluctant to cut prices in order to sell their homes because the alternatives for their savings are so poor. They are wary of putting money into the stock market because of corporate scandals. The bond market is underdeveloped and dominated by government investors. Finally, if homeowners put their savings into the banks they face a negative real interest rate.
So homeowners lack incentive to sell their homes given the dismal alternatives. Moreover, the major distortions caused by financial repression have been in place long enough now (since 2003) to permanently alter expectations for the housing market to artificially high levels.
Despite the current lull, it is widely expected that the current restrictions will eventually be lifted and property prices will begin to rise again. Homeowners, who aren't facing the same financing crunch as property developers, feel little pressure to sell at a discount because they believe prices will eventually go back up.
As IMF Mission Chief for China Nigel Chalk recently pointed out, China continues to play "whack-a-mole" with the property market. The government tries to strangle property price increases policy-by-policy, but has left unaddressed the underling driver of the problem, financial repression.
The two graphs below show that investment in real estate and floor space under construction are roaring ahead, indicators that developers believe housing prices will increase in the future.
If the Chinese property market bubble bursts, it will not be because of government policies aimed at curbing speculation. Instead, it will be when households are given better options for their savings. This in turn will generate a significant change in the expectations that have driven investment in real estate in recent years.