China's Real Estate Doldrums is a Foreshadowing
Expansion of commentary offered to Investopedia and Nikkei Business Asia
In the middle of the month, Investopedia and Nikkei Business Asia reached out with questions regarding China’s economic health as a follow-up to an article published near the end of August. The resulting article by Investopedia contained a significant portion of the responses sent; the input given to Nikkei might still be WIP. Read on.
Questions from Investopedia:
According to Bloomberg, "China’s credit demand improved, deflationary pressures eased, and the yuan rallied, adding to a recent trickle of signs that the economy and financial markets may be stabilizing after a sharp downturn." Do you believe that this will make a significant difference in China's economy? Why or why not?
Throughout July, the Chinese government introduced a successive slew of measures to boost consumption of goods and services, including tax rebates for small firms and households. In June, China’s central bank cut loan prime rates (LPR) to give additional liquidity to loans in general and increased its relending and rediscounts quotas by nearly $28 billion specifically to prop up farms and small firms. Absent such heavy measures, these slight improvements seen would instead be a repetition of trends seen in past months: a general tendency for declining consumption.
While the improved stats might compel a bullish argument for some investors, they don’t address an overall concern: decreasing affordability given tight wages and rising costs. Without addressing the latter, repeated interventions will have to become the norm to keep these stats running. Addressing the latter is a deeper issue with substantial pain points, which the Chinese government is unlikely to take on until its appetite for intervention has ended.
How will this affect US banks and the US economy overall?
US banks have seen an increasing loss of deal flow share in China. In particular, China’s outbound deal flow peaked in 2016 and Hong Kong’s IPO market has been weak in the year so far. Additionally, placing offshore shares of Chinese companies into Western exchanges have been inviting increasing scrutiny as a “soft standoff” continues between China and the West. Despite several years of aggressive efforts by US banks and despite China typically accounting for more than half of their Asia deal revenue, the fact remains that they’re being increasingly relegated to the second tier while local institutions like Citic and China Securities continue to reign supreme. US banks are presently restructuring their personnel in Asia as a result.
While trends indicate that US banks’ bottom lines may be affected, the US economy will see relatively fewer implications: China is a feeder for US consumption and the US is a substantive supplier of energy and mineral resources to China. Deflationary forces benefit the buyer more than the seller while China’s consumption likely wouldn't soften enough to mark a massive impact on US exports.
Why is China's economy in such bad shape, and what needs to happen before it can recover?
Since Deng Xiaoping moved to engage with the West, China’s policies have emphasized growth at all cost. To remain the dominant crucible for Western consumption, it has to produce goods cheaper than from a plethora of production alternatives in Emerging Markets economies around the world. While growth created a boost in incomes, cost competitiveness imposes an upper cap on wages and other sundries. Rising incomes boosted real estate to the forefront as a preferred means of investment and made it a significant pillar of Chinese economic growth. However, with ever-increasing supply and diminishing demand due to affordability, quality and valuation concerns, this pillar is now highly stressed.
With increasing moves to shift production shifting away from China stressing its manufacturing pillar and affordability impacting its real estate pillar, Chinese policymakers are left with propping up consumption via incentives and increased public spending on the likes of infrastructure. This is an all-too-familiar Red Queen’s Race.
Short of a comprehensive policy revamp by the Politburo, there will be no quick solution to this; instead, there will be a series of stop-gap measures to iteratively shore up the stats.
Any additional thoughts?
China’s wavering fortunes comes amidst the backdrop of improving economic data from India, ASEAN, Latin America, Central Europe and parts of Africa. For investors, there are plenty of options to peruse for global diversification outside of China. All in all, it’s a very interesting time to be in the markets.
Question from Nikkei Business Asia:
Transaction for secondhand homes in Beijing has doubled one week after the announcement, according to local media, while in other cities, it was muted. Will the series of support, which includes easing hukou or household registration lift the otherwise subdued demand for the property sector in coming months?
And if the support will ultimately lead to the return in business confidence and household demand in coming months?
Principal uptrends in property prices, land prices and rent over the past year in both year-on-year (YoY) and month-on-month (MoM) terms have largely persisted in regions immediately surrounding the cities of Beijing, Shanghai and Shenzhen. Across the rest of China’s cities, both MoM and YoY trends have been flat or down.
It’s important to note that China’s real estate is largely propelled by the sector being considered as an "investment class". The likes of Beijing, Shanghai and Shenzhen are at the “top tier” of this class which imparts some directionality on prices in the rest of China’s cities. The rise in secondhand home transactions in Beijing, Shanghai and Shenzhen only registered a massive upswing recently after the criteria for "first-time homebuyers" was tweaked such that buyers already with homes and mortgages outside of these regions can now access preferential mortgage rates.
However, absent consumption via actual residency, there is little empirical support for price rises. This is why other regions outside of the “top tier” have been in a slump. The easing of hukuo primarily supports migrations to cities with less than 3 million residents, where median household incomes tend to be lower than in Tier 1 cities such as Beijing, et al. It’s difficult to imagine there being a significant propping up of the entire sector’s high land and property valuations due to migration. The core factor behind the slump in overall consumption via actual residency has been a rising lack of affordability impacting the average home buyer in China.
Mid- to high-income household buy-ins as an “investment class” will likely sustain price uptrends in Beijing, Shanghai Shenzhen and even Guangzhou. However, this cannot be construed as rising demand across the length and breadth of China.
For a “Big Read” on other matters, the ever-popular “Dharma” series traces the evolution of Eastern faith and philosophy. Here’s Part 1, Part 2, Part 3, Part 4 and Part 5, followed by the ancillary Part 6 and Part 7 discussing Malaysia’s and Indonesia’s spiritual history. Also, click here for a list of all articles published.