A Chinese hard is not an option, at least while there are other options.
So, I have been asking myself for the past few months how to avoid a hard landing, or to delay it at the very least. The most popular defence of the bullish camp (or the most popular argument against the bearish camp) is that the government and the People’s Bank of China are able to prevent a hard landing (translation: government and PBOC are omnipotent). The government may use fiscal stimulus again, and/or the PBOC may have rooms to cut interest rates and reduce reserve requirement ratios.
I don’t disagree that there are things that the government and the PBOC can do, but there is still a dilemma here. Inflation remains well above the target (although it has probably peaked), making the case for outright monetary easing somewhat difficult. If the PBOC does ease now, that would simply mean declaring a premature victory on inflation fighting and the real estate bubble. Of course, I can’t really rule that out, and that would delay the inevitable, and does present an upside risk in the near-term.
If inflation and the real estate bubble is still the top priority, that means policy easing isn’t yet on the table. If that’s the case, some of the problems that we are seeing right now will likely get worse before getting better. We are already seeing some strains in terms of funding small and medium sized businesses, and real estate developers are having trouble funding themselves as well. If the overall tightening stance continues, real estate developers will be forced to cut prices in order to obtain cash, and some will probably go bankrupt. That will weigh on the real estate market.
A Financial Times report suggested that Beijing officials might be rather happy to see some failures of real estate developers:
“There are some developers who are facing funding pressure or have even been cut off. This is something we are happy to see,” said one of the officials, who asked not to be identified. Developers were like “dragons and fish jumbled together”, he added, referring to a mixture of high and low-quality companies for whom a consolidation process was “very necessary”.
Furthermore, Deutsche Bank is expecting a 10% correction in home prices because it would be a disaster if prices are allowed to fall by, say, 30%:
Those who understand China’s political economy should know that a 15% decline in average property prices in 35 cities within a few months must be accompanied by a range of economic and social consequences. These will include a sharp decline in real estate transactions, a visible deceleration in real estate investments, rising unemployment in the property construction and agency sectors, a further decline in construction material prices, demand destruction due to inventory destocking, and finally a worrying decline in GDP growth and the resulting concern of social stability. In other words, the government will most likely not tolerate a 30% drop, and probably not even 15% in our view. We expect real estate policies will likely be relaxed way before a 30% price decline is observed.
I hear that!
The next question is, however, can you be happy to allow some property developers to fail miserably while at the same time limit the fall in home prices to within 10% so that you can avoid “a range of economic and social consequences”, in other words, hard landing?
Or, if Deutsche Bank’s judgment is true that policy will be relaxed well before property prices fall significantly, we can question whether that will be enough to save the market if the downturn has passed the point of no return. We should all understand that once a trend is established, it is not easy to turn around. Property prices in the US have failed to bottom-out even with ultra easy monetary policy, for example.
So, the real question is, how do you engineer this landing, which requires the wheels on one side of the aircraft to fall off and a gentle touch down on the other side.