The Chinese overbuild is massive

From Nomura via FTAlphaville today comes a very important chart:


China’s over-building and excess real estate supply is widely regarded to be concentrated in lower tier cities, especially tiers 3 and 4, where nearly three quarters of construction is currently taking place. Is it any wonder that Soc Gen’s sees it this way:

In summary, we think that real estate investment growth will continue to trend lower, likely to the level of 5% yoy (from 12.5% in June), a level last seen during the 2009 downturn. The IMF once estimated that a 1% decline in China’s real estate investment would shave about 0.1% off China’s real GDP within the first year. And so a 7.5ppt deceleration in real estate investment growth would drag down GDP growth by about 0.75ppt. Hence, we maintain our view that the downward pressure from the housing sector will be immense and the downside risk will be non-negligible.

Therefore, policy easing will most likely continue, but the scope is increasingly limited. More local governments will relax purchase restrictions and cut the property transaction tax, but that is unlikely to help much. At the central government level, the decision, at the end of the day, is about to what extent the top leadership is willing to stretch the economy’s debt-absorbing capacity. If it continues with selective easing and only targets infrastructure, in order to offset the kind of property investment slowdown projected above, infrastructure investment growth may have to surge further to over 30%. And this will need to be achieved while land sales are in deep contraction. In June, land sales contracted 6.3% yoy, compared with 1% growth in May.

If the authority chooses to deploy broad-based credit easing, then the obvious question is whether it is really a good idea for China’s long-run prospects. The answer seems to be equally obvious. Hence, the most likely scenario in our view is still selective easing and short- lived growth reacceleration.

That remains the MB base case.

David Llewellyn-Smith
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  1. Raises more questions than it attempts to answer. For instance – I know everyone is looking at housing because its almost wholly outside the realm of government influence and is the sector most run by animal instincts… but surely there has to be a limit on local government debt as well? Given that public construction sector is still substantially larger than the residential sector, and it is it that holds the largest section of domestic debt in China – is it even possible to increase infrastructure investment 30% indefinitely (such they suggest above)? And if local governments cut the property transaction taxes, given for many of them it provides up to 50% of their revenues – won’t it make their position to service existing debt, let alone take on more debt, even more unviable financially?

    Economic history is not a great guide regarding what could happen next, given as far as I know, there has never been a precedent like modern day China since maybe the ancient pharaohs of Egypt.

  2. Local government in China has been heavily dependent on the revenue from land sales, this has allowed it to keep actual taxes low.

    They have deliberately run their urban planning in a way to maximise the price of land they sell, and when some sort of a crash comes, there will be many developers who paid far too much for sites and investors who paid far too much for finished or semi-finished apartments.

    Meanwhile there are possible beneficial effects from the fact that at least taxes have been lower because the price gouging has actually been done by government – ultimately the investors who lose their money will have paid a de facto tax. But of course when land sales reduce, local government will need to impose new taxes.

    I don’t know whether there has been a deliberate plan all along or whether these things have happened by default. If there is a deliberate plan, the next stages to follow the end of the urban property bubble will be already known in the CCP leadership.

    • all those apartments in decrepit polluted cities of 15 million poor people that we have never heard the name of that rich shanghai people own will not be worth anything near what they think when reality finally rears its head in china

      people refer to others when i have visited as this person owns 10 units and this person owns 20 units. all these units are empty cement shells which they bought for a pittance and are now apparently worth 300k each and from which they have borrowed this amount against for a luxury car a LV bag and a home overseas.

      the CCP has an enormous problem here, which, is nothing compared to the fact their food is cancer, their air is cancer and the water is polluted and has nearly run out.

      What has saved the CCP so far is a lack of education and the fact that most would prefer a LV bag to clean air and food.

    • If there is a deliberate plan, the next stages to follow the end of the urban property bubble will be already known in the CCP leadership.

      Of course the existence of a plan is a very long way from guaranteeing the plan’s success.

    • “If there is a deliberate plan, the next stages to follow the end of the urban property bubble will be already known in the CCP leadership.”

      Phil, how much control do you think the CCP actually have over their economy? I often wonder. I’d certainly love to be a fly on the wall in the top leadership meetings. Of course the huge quantities of pride that would be within the CCP would conceal any of their uncertainties or lack of control around China’s future.

      • I agree – I am just thinking out loud, that it is quite possible they have managed it deliberately as it has gone so far. All that land sales revenue in lieu of taxation – quite possibly there won’t be any bailouts, in contrast to western countries where the bubble revenue hasn’t even been captured by government in the first place. The Chinese could actually be doing the “bubble route to growth” deliberately, with “Chinese characteristics” that avert the moral hazard of the western approach. The Chinese may end up with a very chastened middle class that won’t speculate on property ever again.

    • casewithscience

      Japan has a population of 125m and GDP of 5tril. China has a population of 1.4b and GDP of 14tril.

      Japan has almost purely internal ownership of product lines. China has a bizarre system which is open to manipulation by foreign designers and manufacturers.

      They are very different and I cannot see the same stagflation happening in China as did for Japan. The social undercurrent in China is nowhere as stable as it is/was in Japan. Where Japan just stagflated, China could erupt in social disharmony.