The Real Estate bubble in China
This paper will discuss the issue related to real estate bubble in China and the following section will define the parameters of this issue in detail. Currently, China is the fastest growing economy in the world and so far the main force pulling the world out of the recession however according to leading economist, the growth has its effects especially on the real estate sector in China. After the global financial meltdown in 2008, the prices of real estate have skyrocketed in the urban centers across China. According to regional experts, some areas have experienced a rise of around 150 in real estate prices during the last year and the demand for housing in China is still on the rise. Chinese growth rate is expected to be around 9 however, due to the global recession the export figures have declined which has led the country to shift its focus from global consumption to domestic demand as their primary engine of growth. Earlier, the Chinese government had tried to promote the real estate through easy real estate lending and development to boost growth. According to Chinas Central Bank, mortgages for new homes in the first nine months of 2009 have quadrupled from the amount borrowed during 2008 (Smith).
Analysts around the country are concerned due to the current aggressive stance of the government which has produced a tremendous rise in construction, lending and speculative buying. Many people fear, that if the Chinese authorities dont take quick action then the housing bubble would increase in its severity. Many experts believe that the lack of solid data to justify such high levels of housing sector prices is a proof that the bubble is developing as it is typically defined as the prices at higher level without any economic justifications. In this case, the investors purely base the purchase decision on speculation hoping that the prices would increase in the future without any solid reasons such as the change in the demand or supply of houses in China.
A similar situation developed in the Japan during the early 1990s when the real state and stock prices were inflated and according to many an economic bubble had developed. The reason it had developed was the same as financial assets became lucrative investments due to easy availability of credit and appreciation of the Japanese yen. However due to the corrective policy making the real estate bubble was elongated (some say until 2003) which minimized the losses. One of the measures taken by the Japanese central bank to combat deflationary pressures during these was that it reduced interest rates to approximately zero, thus the bubble collapsed gradually rather than catastrophically (Amyx 52).
However most people believe that the burst in still further and can be prevented through effective policy making and management. Looking at the following situation, the Chinese government has tried to calm the real estate bubble through variety of policies which include the higher mortgage rates and the larger down payments. However it is not only the government policies but other financial and cultural issues have also played a part in the development of the risky bubble.
After discussing the issue from the viewpoints of Chinas regional real estate experts, local and foreign people, investors and Chinese Central Bank and also comparing it with the similar case in Japan, the paper will now evaluate the issue in order to ascertain the main cause of the problem. China announced a stimulus plan of around 586 billion for the real estate sector which is 17.8 of their GDP as opposed to Americas which stands around 5.7 of their total GDP. There is visibly a link between the ultra loose monetary policy and real estate price hike the availability of easy money has lead to the rise in the demand for real estate which remains the one most lucrative form of asset investment in China. The central bank is under tremendous pressure to control the current situation through tightening of the monetary policy and credit restriction in order to control the price hike in real estate (Mufson).
Another reason for the price hike is rooted in the investors bet in Chinas currency, the Yuan which is expected to be revalued upwards in the near future. These bets are largely foreign in nature and are largely based on the expectation that the investment in Chinese assets such as real estates will increase in value once the revaluation of the currency takes place. The lack of performance by the Chinese stock exchanges has led the local and foreign investments to be poured into the real estate sector which is based on speculation about the future.
Another reason is Chinas overall economic growth which has led to the development of luxury houses in city centers which are designed for wealthy foreign corporate executives and consists of around 90 of new constructions taking place. These houses are unaffordable to average Chinese households as a result these new homes are sitting empty and are largely purchased as investment. Moreover, the current boom has led to a high price to income ratio and a high price to rent ratio for real estate, hence many Chinese firms in the industry such as chemical, steel, and textile are opening real estate divisions expecting higher return than their core businesses (Barboza).
Most of the land in China is owned by the government and a huge proportion of government revenue comes from land sales therefore the government needs money and any measure taken in order to curb the real estate market might be ineffective. The flip side also points out that the real estate boom has led to the development of other industries such as construction and steel industries which provides income to numerous families and is a source of growth to the country. There is also an increasing demand in the housing sector which is fueled partly by the millions of rural migrants moving from villages to large cities which would lead to the development of the country.
The lack of housing for the middle income groups which include most of the working class in China is a cause of great concern for the government as this would later develop into social instability and protests. The large number of mortgages in China and the continuing relaxed credit policies is leading China towards a housing bubble which would destroy the developing banking sector in China along with lifesavings of numerous investors. However, lately, the central bank has shown great concern and vowed to impose new limits on the speculative borrowing through deposit requirements for housing.
The evaluation also shows the other side of the issue that a bubble does exist but it wont explode due to a lot of factors to support the bubble which largely include the strong buying power of the existing consumers. Other factors include economic growth, rising family incomes, migration of labor to cities, high demand for housing, and banking system which is less vulnerable to mortgages compared to banks in the US or Japan. These are the reasons which can protect China from a real estate meltdown for years to come (Barboza).
In short, our evaluation of the issue of real estate bubble in China points out following key factors. Chinese citizens have limited access to foreign investments therefore it has artificially increased the appeal of domestic investments such as property which is the only viable option. Chinese culture also requires home ownership as a source financial independence therefore there is a high demand for housing. The low level of property tax has led to the development of real estate into speculative instruments without any carrying cost or risk. The unexpected nature of the stock market and regular slumps have left investors more interested in real estate options which are considered much more rewarding and less risky long term investments. Speculation in Chinese real estate is largely due to the easy availability of credit in the country which is both in the form of FDI and the local loose monetary stance however the dependency of local government on real estate as a source of revenue is another reason for the lax attitude of government towards the recent price hike. The government also aims to impose other restrictions in order to curb the crisis.
Now the paper will recommend some solutions for the issue of real estate bubble in China, but first we consider what Chinese government has done so far regarding the resolution of this problem. The government has stepped in to check the current situation and devised a few important strategies. This year a capital gains tax is to take effect on residential property sold within two years of purchase. In addition a new law is to be implemented which would require the owner of residential property to settle the mortgage before selling the property. However, these measures are moderate steps which would take time to calm the current crisis (Mufson).
For implementation of any proposal, the government has to act smart and take a balanced approach towards the situation, as from one point of view, the massive stimuli and easy credit has spurred a massive mal-investment in unneeded assets, marginal infrastructure projects and speculative luxury market which is sitting empty as investment. The other point of view signifies the critical role of domestic investment in supporting the growth and leading to an economic recovery locally as well as internationally, at the same time supporting urbanization in China. Hence the set of proposals should be implemented such that its net effect tries to contain the real estate bubble as well as maintain the required economic growth.
The government can take a number of actions such as increasing the interest rates in order to curb the money supply and the availability of easy credit and imposing capital gains tax along with sales tax. It can provide other venues for investment, making them more lucrative than housing, to direct the local and foreign funds to other markets such as capital, money, futures and commodity markets. It also has a proposal of making the first transfer of property exempted from tax so that middle income people from rural areas can find housing in urban areas. At the same time, the government can apply restrictions on transfer of real estate by imposing taxes on secondary transfers and full payment of mortgages before transfers which would reduce the volatility of the real estate sector (Smith). However, all these proposals cant be applied at the same time and for the right time to put checks on the growing real estate sector, the government should wait for other indicators of growth such as exports to show more positive signs which would provide the support for the overall growth targets without damaging the economy as a whole.
The fears regarding the implementation of these proposals are that these measures could backfire as the exports are still weak and the immediate effect would be detrimental for the growth. Restraining the real estate market too soon could effect growth as it accounts for 10 of GDP in the current situations. On the other hand, further tools of deflating the bubble could have other negative impacts on the economy, such as transaction tax on home sales aimed at reducing speculative trading may reduce the size of the bubble but would discourage real buyers which would suppress the demand unnaturally in the market.
Moreover, the revival of the real estate industry is the key reason that Chinas economy is emerging from the global recession. With China acting as the engine of global growth, any attempt to restrict its growth prospects because of such issues as real estate bubble might hurt the global economic revival. The world has also placed confidence in Chinese consumers to increase their spending to uplift the global trade. Hence it is the high time to boost domestic consumer demand and investments in China. Therefore the authorities in Beijing have to act smart in their attempt to shrink the bubble through balanced and delicate approach without adversely affecting the economic growth.
Furthermore, looking at the history of economic bubbles, it would be a point in time when the investor would loose the confidence which would lead to panic selling. The prices may fall reasonably low and the investors would wait on the sidelines waiting for the prices to hit the bottom which would shatter the whole real estate market in China. This would harm the major banks whose balance sheets consist of large number of mortgages and collaterals based on private property. Hence this requires the development of overall financial sector of China through introducing better practices and standards especially in the case of mortgages. This would ensure the integrity and firmness of Chinese financial sector in case a real estate bubble burst.
The simple conclusion of this paper is that whether the real estate bubble in China seems to be a myth or reality, the evaluation of the factors clearly reveals that there might be problems in the future which may affect the real estate prices. If the crisis does surface then the major portfolios of investors may substantially decrease in value and also financial institutions may face difficulty in handling the devalued mortgages. Moreover, world economy will be hurt as China presents itself as the engine of growth for the currently depressed world trade. Hence keeping all these factors in view, a more balanced and effective set of solutions should be selected for containing the bubble from escalating.