China targets property sector for deflation

Goldman with a note on how China is targeting the epicentre of global iron ore demand for deflation:

Striking a balance between growth and stability. We agree with the chairman of the CBIRC that the property sector is one of the gray rhinos in China. In our China Credit Conundrum published in 2013, we cited a property sector collapse as a potential trigger for a significant credit event in China. Though with the sector being a major contributor to China’s GDP, policymakers have adopted a balanced approach – on one hand, the sector has been key in the past to boost activity levels, has been relied upon by local governments for fiscal revenues and to satisfy consumer demand; on the other hand, various risk control measures have been introduced to prevent asset bubbles forming, including home purchase restrictions and limitations on second home mortgages.

Leverage has continued to rise over the past decade. Despite this balanced approach, leverage related to the property sector has risen sharply over the past decade.We estimate the total amount of borrowing by China property companies reached RMB31tn1at the end of 2020, representing a 5-fold increase since the end of 2011, with the largest increase stemming from domestic bond issuance and shadow banking (Exhibit7). Furthermore, mortgage lending has increased at a faster pace in recent years, andthe total amount of mortgage loans outstanding has reached 34% of GDP, exceeding our estimate of 31% of GDP for property developer debts (Exhibit 8). We believe these factors contribute to the continued focus to reduce risk in this sector, and policymakers have repeatedly stressed in recent years that housing is for living, and not for speculation.

We assume 50% of domestic and foreign LGFV bonds are related to the property sector. In a Dec 2020 report, S&P estimated half of the LGFV sector debt is from land projects. Property developers’ borrowing from shadow banking is estimated by trust and non-trust products. Trusts’ investments in the property sector are disclosed by the China Trustee Association. The non-trust portion is estimated at 25% of shadow banking credit assets (excluding trust). In 2014, China Wealth (a Wealth Management Product (WMP) website underCBIRC), disclosed that around 25% of WMP assets were invested in the property and civil engineering construction sectors.

Targeting price stability by slowing down supply and demand.

As noted by our China economics team in a recent report, policymakers are aiming for price stability, and to prevent excessive risk buildup down the road. As a result, a number of policies have been introduced in recent months:

1.Three Red Lines – These were introduced in August 2020, and set three quantitative thresholds that property developers have to comply with in order to increase leverage on their balance sheets.

2.Property Financing Caps- The PBOC announced caps on property lending by commercial banks, effective on Jan 1, 2021, to manage the concentration of property loans in the banking sector.

3.Land Supply Policy Reform- On Feb 24, 2021, the Ministry of Natural Resourcesguided 22 major cities to carry out land supply policy reform by limiting the number of land auctions/bidding to a maximum of 3 times per year and more even allocation throughout the year. Our China property analysts expect this will improve transparency in the land market, which eventually should help stabilize land and property prices.

A more surgical approach, and more scope for credit differentiation. Our Chinaeconomics team noted that policymakers have adopted a more surgical approach to controlling the property sector, meaning that the shifts in policy stance is more eincremental but higher frequency, and importantly for credit, more localized (i.e., different policies even within the same city). To us, this more micro approach towards policy implementation suggests there is further scope for credit differentiation, with more defaults likely for developers that fail to adapt to the new policy environment, whilst those better positioned could see opportunities to gain market share. In the long run, these should help to ensure stable growth, and better allocation of credit.

David Llewellyn-Smith
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