China Briefing
Quarton China Perspective – July 2011
Thirty-years ago, after Deng Xiaoping’s Open Door Policy began, China’s economy took off on a trajectory that seemed unstoppable. Recently, China has hit some major bumps in its growth story causing many to question its future. Rising inflation, a rocky real-estate market and large levels of municipal debt are just some of the escalating problems that the Beijing regime is facing this year. In the following paragraphs, we take a look at each one of these issues to better understand their impact on China’s future.
At the top of the Chinese government’s agenda this year has been a continuing battle against rising inflation. Despite six successive months of raising the banks’ capital reserve ratio and multiple interest rate hikes, inflation has continued to rise. The Beijing regime points to the latest CPI numbers of 5.5% annually, but the underlying issue is food price inflation, which topped an annual rate of 11.7% in May. Capital controls, a credit crunch, and an appreciating RMB all point to reduced inflationary pressures in the second half of the year, but China’s middle and lower classes will continue to feel the pain of rising prices and reduced purchasing power for the foreseeable future.
China’s red-hot real estate market has continued to stagnate during the first half of 2011. Turning back the clock to the financial crisis of 2008 and 2009, there has been growing realization that much of China’s massive $3 trillion stimulus package which was supposed to be earmarked for infrastructure projects and state owned enterprises ended up being redirected to real-estate deals driving up land prices. Over the past year, the Chinese government has put in place measures to temper real-estate sales, including raising the minimum down payment for mortgages on second homes to 60%, limiting real-estate purchases in certain cities and enacting China’s first property tax. These measures collectively have helped to cool an overheated market, but the bigger fear lies in a continued downward trend.
Municipal governments have the greatest fears of slowing real estate markets because they rely upon them for a majority of their revenue. Beijing has directed lofty goals towards China’s local governments, but has been reluctant to backstop them with government funding. As a result, municipalities strapped for revenue have pledged land as collateral for debt. Much of the borrowed money is directed towards infrastructure projects with very long payback periods. As a result, local governments are often forced to sell off land at auction to pay down their debts. As reserve ratios increase and real estate prices decrease, local governments are beginning to feel the burden of being overleveraged.
Beijing has addressed these issues head-on first by combating inflation aggressively through capital controls and appreciating the RMB. Although the results have not been as fast as expected, all indicators point to improvement in the second half of the year. Real estate prices have trended downward in a welcome sign to the cash strapped lower classes, but the net impact to the overall economy has not been positive. UBS estimates that property construction contributed as much as 13% to the overall Chinese GDP. As much as the Beijing government is focused on central planning and a heavy hand in the economy, it is still no match for market forces. Despite Chinese meteoric rise, it is still susceptible to the economic gravity that regulates the markets. Though many have called for a hard landing in the coming years, the underlying economy in China is strong. Though the bumps in the road are a wakeup call, they are hardly an indication of an impending crash.
