China has barely started to come to grips with its overheating woes. But its two latest challenges – the spiralling cost of food and land – are the ones with the greatest potential to cause social unrest. They also expose the dilemma at the heart of the country’s attempt at a mixed communist-capitalist system: often state intervention aggravates problems in the market rather than resolving them.
It’s hard to know which statistic is the most worrying. First, there’s the consumer price index (CPI), which showed inflation rising by 6.5% year-on-year in August, with food prices surging by a startling 3.3% month-on-month.
Then there’s the Shanghai Composite Index, a broad measure of the mainland’s leading listed securities, which rose by an astonishing 16.7% in August, pushing the index beyond the 5,000 mark for the first time. That rise came despite concerted government attempts to convince mainland investors not to sink all of their available cash (as well as that of their family and friends) into listed enterprises.
And what of China’s property prices? They have been rising for years, but again August provided yet more evidence of bubbles in the real estate sector. That month, Shanghai’s second-hand housing index surged 6.03% – the fastest rate since 2004 – with home loans at the city’s local banks rising by Rmb7.13 billion ($950 million), up 21.5% month-on-month.
Real estate prices have been rising steadily for years, particularly in the bigger Chinese cities where employment is booming, but many aspiring middle-income mainlanders have already been priced out of the market. A survey released in December 2006 by HomeLink International found that housing in Beijing cost, on average, 9.4 times the city’s median household income – almost twice the level of other emerging markets.
“It’s clear that we have a new type of inflation – asset price inflation,” says Qu Hongbin, chief China economist at HSBC. “House prices in the big cities are rising much faster than people’s incomes.”
Qu says real estate prices are being propelled further by the country’s almost ludicrously bubbly stock market, which is making people believe they are richer than they really are.
Concerned that further real estate speculation will cause social unrest, with more workers priced out of the market, Beijing finally acted in late September, raising costs for buyers of commercial real estate and second homes (though, noticeably, not for those buying high-end luxury houses).
China’s central bank [PBoC] governor Zhou Xiaochuan said recently that while “the PBoC is quite concerned with asset prices”, monetary authorities cannot focus too much on them when they set policies. “When we make policy, we keep them in consideration,” he said.
China’s central bank, as well as the banking regulator, announced that mortgages on second homes would rise to 40% of the total sale price, up from 30%; and 50% for commercial property. Buyers would also have to pay a higher interest rate: 1.1 times the benchmark one-year lending rate, or 8.019%.
Yet despite this measure, few expect property prices to ease, with supply constraints playing a role in the problem alongside demand. Writing for the Hong Kong office of GaveKal Research, Arthur Kroeber, also a director at Beijing-based research firm Dragonomics, predicted strong double-digit growth in nationwide property prices in 2008.
Mainland real estate prices are caught in a perfect storm, rising precipitously because they are backed by genuine demand, driven in equal measure by natural speculation, an economy growing at just shy of 12% a year, and a lack of other viable investment alternatives.
Market alternative
The one, obvious alternative investment channel (low-yielding bank deposits aside) is the very one that is even more out of control than real estate: China’s stock markets. It is, of course, well documented that Chinese stocks are having a stellar year – not a single one of the 1,550 mainland-listed corporations has seen its share price fall this year.
It’s also true that the authorities fear a protracted market crash, which will wipe out hundreds of billions of dollars of market value. That won’t happen overnight – China limits daily gains and losses in the broader market, or any given security, to 10% each day – but, like the downturn that crushed a generation of mainland investors between mid-2001 and late 2005, any bear market could last years. And with the Shanghai index trading at 50 times reported earnings, and many stocks much higher, some type of crash – whether a minor shunt or an indiscriminate mass collision – is inevitable at some point.
Many argue that a crash will not happen for some time, but that, when it finally occurs, it will be spectacular.
Fraser Howie, an analyst at CLSA and the author of Privatising China, a study of the mainland’s stock markets, says the market will “continue on this dizzy ride for some time”, for two reasons: ample liquidity and a continued restriction on the supply of shares. China still has to deal with a huge overhang of unlisted state-owned “legal person” shares, which comprise the bulk of the securities of any mainland-listed company. Given that these will not become available to investors until late 2008 or early 2009 – and that the state will be reticent about selling down any of its holdings, for fear of knocking the market off its wobbly pedestal – the supply of new securities is likely to be limited.
“All sorts of Olympics nonsense and the rise of the China story will continue to boost sentiment, and without a complete economic about-turn, it is hard to see how this party will stop,” notes Howie. “But it will stop, and it won’t be pretty.”
That, for many, is the billion-dollar question: when will the market crash? Many believe that China simply will not allow it to do so before next August’s Beijing Olympics. Yet some correction is ultimately both inevitable and desirable. “The stock market is the worst part of asset price inflation,” notes HSBC’s Qu. “It will burst, and this will not be good for the economy. So the question then is: how does it burst and when will it burst.”
Qu presents two possible outcomes. First: the government intervenes in the near term, attempting to gently let air out of the bubble and manage any decline. The second involves the government ignoring rampant speculation, hoping against hope that somehow stock prices will rise forever. “All that this means is that the trouble will get bigger before everything crashes,” says Qu, “and this will mean greater risk for the economy.”
Real life
For the real economy as for equities, supply shortages are again adding to demand-side pressures, so there are questions surrounding the decision by a bevy of government departments to try to rein in the price of energy, water and staple goods. Pork prices rose by 80% year-on-year in August, with the price of edible oils rising 35% and vegetable costs up by 23%. Fearful that rising prices would lead to social unrest, the government departments, led by the powerful state planning department, the National Development and Reform Commission (NDRC), on September 19 froze the price of oil, water, gas, electricity and public transport until the end of the year.
Yet many believe price freezes will only make it harder for Beijing to rein in the country’s blisteringly hot rate of growth. Part of the reason China’s economy is expanding so quickly is because there is little disincentive among provincial authorities or corporates to slow their rate of investment. Zhang Jingguo, the chief economist at Tai Kang Asset Management in Beijing, says that allowing the price of basic commodities – particularly oil for industrial purposes – to rise naturally would force industrial output to slow at a natural rate, with corporations “forced to increase energy efficiency and thus to control their energy consumption”.
“This would create a more sound and stable economic rate of economic growth,” says Zhang, who notes that greater efficiency would also help improve the country’s virtually unbreathable air. “If you look at the country’s pollution problems, China’s GDP growth is unsustainable,” he adds.