George Magnus is on the hustings again today expressing a bearish view on Chinese property that makes perfect sense to me and is a key plank in my very bearish view of iron ore. From the FT:
Market optimists insist it is going through an “adjustment” similar to previous property downturns.
A more sober view, however, is that because of unprecedented overbuilding, and leverage nurtured by the eruption of shadow banking, this downturn is both more serious and systemic. China is probably in the first stage of a denouement of the property- and construction investment-led growth model of the past 15 years. Financial markets are having trouble pricing the implications.
Property accounts for about 25 per cent of capital investment, and roughly 13 per cent of gross domestic product. Incorporating associated industries, such as steel, cement, and construction machinery and materials, would raise the investment share of GDP to about 16 per cent.
If this leading edge of China’s growth model saw a fall in investment growth from 20 per cent to 10 per cent, economic growth would slide by roughly 2 per cent, taking into account secondary effects. The stream of downward revisions to economic growth is not over yet.
…In spite of rhetoric that market forces should be allowed a greater role, the authorities have resorted to administrative stimulus by stealth as the property downturn has gathered pace.
Financial markets have not yet priced for the end of China’s long-running property boom. With or without short-term palliatives, construction will support but no longer lead GDP growth, and the sector will have to work off oversupply and leverage, while adjusting to new legal restrictions affecting land clearance, resettlement of people, and agricultural land preservation.
At the very least, this downturn will not be over until we have had several quarters of declines in the ratio of credit to GDP and in property sales and transactions, non-financial sector deleveraging, and more defaults.
That is my base case. It’s not a terrible outcome for China at all. In fact, it’s terrific for future growth prospects and stability. But for Australia it’s far more challenging.
More support for the view comes from Guan Zhixiong of Nomura via Investing in Chinese Stocks (forgive the Chinglish):
I think housing prices in major Chinese cities has far exceeded the equilibrium level, and is not sustainable, and thus can be called a bubble state. There are two indicators can verify my point. Price earnings ratio is an indicator of major cities. Last year, Beijing’s price earnings ratio of about 19 times, Shanghai, Shenzhen has more than 17 times. In other words, a family now eat or drink in Beijing, also requires 19 years of income to buy an average area of housing. This is even higher than the 20th century, the 1980s [ News Price apartment review ] the second half of the bubble level in Tokyo.
Affect the real estate market adjustment on China’s economy
The housing market has entered a period of adjustment, China’s economy will suffer consequent. What impact? Yes, the real economy from the financial analysis of three aspects of finance. From the economic entity perspective, last year, real estate development and investment of up to 8.6 trillion yuan, equivalent to 15.1% GDP in; crude steel production was 780 million tons, accounting for about half of the world, the housing market downturn will lead to a decline in steel production. The iron and steel industry and includes overseas iron ore correlation, energy, shipbuilding and other industries, etc., is very high, so its effects are not confined to spread in China, will also affect the global economic situation.
From the financial side, real estate taxes, and as an important source of revenue for local land premium is equivalent to a total of about 10% GDP. Housing market downturn will give local governments finance especially great pressure. Thus China will not be able to re-scale as in the past of public infrastructure investment.
From the analysis of the financial sector, in 2013 real estate loans of financial institutions is more than 14 trillion. Fortunately, in 2010, after China has taken some measures to squeeze the bubble, including the upgrading of the mortgage ratio of the first payment. Since the housing down payment ratio is currently 30%, higher proportion of houses for investment purposes, the third suite can not even loans. Therefore, even if real estate prices fell 30 percent, the bank still has sufficient buffer space.
China is not Japan
First, the degree of reliance on real estate transactions for the bank’s is different. After the second half of the 1980s, Japan’s bubble economy period, even if not the mortgage, the bank construction, real estate and non-banking financial institutions (including specialized housing finance companies) Loans three real estate-related investment has reached about 25% of total loans . And China is now facing the real estate loans, even including for personal mortgage is included, it accounts for only about 20% of China’s total bank loans.
Secondly, the relationship between the bank and the balance sheet shadow banking differentiated between. In Japan’s bubble economy period, specifically on housing finance company loans are, so if you can not recover, then it becomes the bank’s bad debts in the table. Since this exceeds the bank’s own ability, and ultimately through the injection of public funds to solve the problem. But in China, most of the financial products do not belong to the lending bank statement, so even if the event of default, in principle, the banks have no obligation to compensate customers.
…More importantly, there is a large gap between the two sides on the level of development. Japan was already a mature countries, but China is still less than $ 7,000 per capita GDP in middle-income countries, if we can make good use of the advantage, then, in the future also be able to maintain growth of around 6% -7%.
That’s a bit high for my tastes but the outline is right and even if growth is robust it will not be based around construction, or commodities.
