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In 1987, a young man quit his job at the Hebei Oil Pipeline Bureau and went to seek his fortune in the nascent private property market of Hainan province’s Special Economic Zone. He was Pan Shiyi, now chairman of SOHO China, and one of China’s first private property developers. But he also experienced modern China’s first big real estate bust, when Hainan property prices crashed back to reality following a 1992 bull market inspired by Deng Xiaoping’s Southern Tour promoting his ‘reform and opening up’ policy platform.
Hainan is again at the forefront of a Chinese property slowdown. The government of provincial capital Haikou says it cannot cover its debts and is requesting a third of Hainan’s bond issuance quota as relief. Pan Shiyi, having seen all this before, is aggressively diversifying SOHO’s assets into overseas property markets.
Hainan may be an extreme case, but China’s property market will not return to its glory days of unrestrained growth. Changes to the required down payment for second home buyers and the announcement that the National Housing Provident Fund could be transformed into a Fannie Mae/Freddie Mac-style national housing fund are good policies. They may help ease the pain of the slowdown whilst preventing a devastating crash, but they will not be launching a new property market boom. And nor does the government want that.
The March figures from China’s National Bureau of Statistics (NBS) suggests that China’s property market slowdown will continue through 2015. This data is especially important because January and February statistics are usually distorted by the low commercial activity associated with the Chinese New Year festival. March is the first time each year that a clear picture starts to form of how the property market is faring.
While the NBS 70-City Price Index continued to decline in March, its rate of decline slowed slightly with 50 cities seeing month-on-month price declines, compared to 66 the previous month.
But it was property construction starts that saw the most dramatic drop. Starts have dropped to their lowest level since October 2009, just before the Chinese government’s enormous 2009 stimulus package. This points to where the property slowdown is being felt most acutely, in new investment. Developers are now far less willing to invest in new projects and believe the market environment has shifted dramatically.
Yu Liang president of major Chinese property developer Vanke Group, states that while government policies will help support the market, he is not expecting a major rebound. Yu thinks we have seen the end of the ‘Golden Age’ of the Chinese property market.
As if in unison, as the property market began its outright decline in the second half of 2014, China’s equity market sparked into life. The Shanghai Composite Index has increased roughly 85 per cent over the past six months.
While the Chinese government does not control China’s stock markets, they are highly driven by policy changes. The share of bank financing in China’s financial sector and the associated concentration of risk has been a major concern for Chinese policymakers. The need to diversify risk across the financial system has driven the Chinese government’s support of corporations pursuing direct financing through China’s financial markets.
What the Chinese government really has little influence over is Chinese investors’ hunger for capital growth. With limited avenues for investment, Chinese investors often pile into asset classes all at once. Now that wealth management product (WMP) issuance has been curbed and the property market is declining, equities have become the main game in town for domestic investors.
New brokerage account registrations and margin financing have exploded. Macquarie’s Matthew Smith notes that margin finance positions have increased 175 per cent since September 2014. He further emphasises that, given a large portion of Chinese markets are equity stakes held by state-owned enterprises that don’t trade, margin finance as a percentage of the genuinely tradable part of the market has reached 8.2 per cent. That sets an historical precedent of margin leverage not even seen in the Taiwanese or Japanese stock bubbles.
These are figures that would strike fear into the hearts of most central banks. But the People’s Bank of China (PBOC) is already battling on a number of fronts. The slowing economy, steady capital outflows and the disinflationary trend has tightened domestic liquidity.
This has lead the PBOC to begin, in the words of ANZ’s Liu Ligang, ‘an aggressive easing cycle’ with the weekend announcement of a 100 basis point cut to banks’ reserve requirement ratio (RRR). Most economists expect continued easing from the PBOC during 2015, through further cuts to the interest rate and the RRR.
Chinese markets have surged in response to the RRR cut, but this creates a conundrum. Markets already look overextended on many valuation metrics, yet there appears to be plenty more monetary stimulus ahead. The Chinese equity market rally looks set to continue, but so too does the risk of a devastating stock market crash. This could undo all the careful work the PBOC and other government departments are doing to manage the economic slowdown.
How the government manages the equity market boom without precipitating a dramatic crash will be one of the most important stories for China in 2015. In the current environment one can sympathise with investors like Pan Shiyi who are diversifying into overseas assets.