There is going to be a lot of office space in Ningbo. According to a Savills report from last year, total office stock in the end of 2008 was 1.2 million sq. m. It’s not a small number, but it will more than double - another 2 million sq. m. is on track to be delivered by the end of 2011. We are interested in the Ningbo office market because of a project, so we had to wonder: why?

There seem to be several reasons. First, there are not one but two major “new districts” in Ningbo, government-sponsored development areas that are intended to become significant business districts. (In the case of one, the “New East City,” the intention is to form a new city center, with the city government to relocate there.) These two districts are nearby and appear to be competing with each other, and each has what a person not acclimatized to China’s property market would appear to be an overpoweringly large number of big office buildings under construction. Office rent in at least some of the new buildings, if you are the targeted kind of tenant, is zero. In others, it’s market rate, which is not very far from zero. In addition to these two districts, there is Yinzhou, a suburban district to the south that also has a lot of new offices, and of course the traditional downtown, which far from being emptied out U.S. style, is adding new buildings of its own.

Another reason is more subtle. As the city expands, older villages are being swallowed up. Their land is acquired by the government for development, and the residents given relocation housing, but 10% of the land is retained by the village to provide an income stream to the former residents, who no longer have land to farm. This land is not zoned for investment housing*, so the villages build offices. Unfortunately, in many cases they hire low-quality companies to develop the land for them, and the office space created is similarly low-quality. This results in the newly developing fringe of the city being dotted with new office towers at major intersections, with the rest of the land being occupied by one-story brick warehouses and shops, relocation housing blocks, and vacant lots. It is not pretty to the eye, and with office stock more than doubling in an already shockingly cheap market, it probably will not be pretty to office investors either.

Having said that, after looking around in “New East City,” I have to say that the quality of construction is high, the shipping and logistics positioning seems reasonable, and the phasing of development, with the essential government services such as customs coming in first, makes sense. It’s not a Potemkin village - but I don’t know about the rest of the new stuff.

*It’s actually not a zoning restriction but a land use designation - all land being owned by the state.

Don Johnson is a Senior Economist with AECOM in Shanghai.

Guest contributor, Property, Regional

Second quarter growth in China’s FX reserves was a tiny USD7bln, despite more than a USD40bln addition from the trade surplus.  Slight growth in reserves despite the robust trade surplus suggests hot money was flowing out of China in the last two months of the quarter.

Two years of stability in the exchange rate knocked hot money off the policy agenda for the government: with little chance of yuan appreciation there was less reason for speculators to bring capital into the country.  But the recent announcement of the next stage in exchange rate reform will bring hot money back into vogue. 

Either appreciation against the dollar will be rapid and one way and the result will be increased incentives to bring hot money into the country - providing the real estate and equity markets pull themselves together.  Or appreciation will be faltering with the possibility of two way volatility - in which case speculators will probably find somewhere else to park their cash.

The interest in hot money in China’s policy circles is partly a relic of the Asian financial crisis, and, to a lesser extent, the speculative attack which forced the British pound to crash out of the European Rate Mechanism in the early 1990s. 

Chinese policy markers were horrified by the ability of foreign speculators to bring the governments of Asian neighbours to their knees, and by the humiliation at the hands of the IMF and its austerity programmes that followed. 

China has a closed capital account, so the chances of a similar attack are slight.  But that does not stop the Chinese media worrying about attacks by ‘big financial crocodiles’ (金融大锷 jinrong da e) - as George Soros style currency speculators are referred to.

This is my translation of a short section from a recent SAFE Q&A on the subject:

‘Our investigations in the first half of the year reveal that the vast majority of capital flows were legal and legitimate.  We have not discovered any large organised attempts to circumvent capital controls.  Most hot money is brought into the country through small transactions. 

As for so called ‘big financial crocodiles’, as we still have controls on capital account transations,  any speculative attack would be illegal - and this means that hedge funds and other financial institutions would think twice before trying their luck.

Hot money mainly enters the country disguised as legitimate trade and investment flows.  There are many and various routes.  But typically speculators are not particularly skilled at disguising hot money flows, so it is not that hard to pick up the signs of irregular transactions: 

-Companies in the processing trade will often under price inputs and over price outputs - with the collusion of their customers - to bring hot money into the country. 

-Shipping companies will take payments early and make payments late to increase their holdings of foreign capital. 

-Service companies can charge foreign customers for transport or consultancy services that are never provided, in order to have an excuse to bring hot money into the country. 

-Foreign investment is often disguised hot money, with investment advisory companies playing the role of broker for foreigners who want to make investments in the real estate or equity markets.’

You can see SAFE’s statement here.

Exchange rate, IFIs, Investment, Monetary Policy, Property, Stocks, Trade

There are many sensible arguments to be made on whether China has a house price bubble or not. I belong to the school which thinks the whole structure of the market looks very shaky, but I do tend to agree that without a big change in some of the fundamentals (like a property tax, or interest rate reforms) a crash is unlikely. What virtually all observers can agree on though, is that calling the property market right is one of the most important questions if one is to forecast where the economy’s going to go over the next 18 months or so.

Which is why it’s so important for the government to manage the message on housing policies and mortgages. Cue the desperate scramble to stamp out the rumour that seemed to be gaining ground in the last few days that policies - notably those on third house mortgages and buying by people from outside the local region - were set to be adjusted. Even the China Banking Regulatory Commission was called in to stress that “the policy requirements and standards have not changed at all”.

Really, this should come as no surprise. It’s true that the sudden drop in housing transactions since the tough measures were imposed in April has made policy makers nervous about their potential to send the economy into a double-dip downturn. But although even the government’s rose-tinted house price index is showing a monthly drop in national prices (down 0.1% in June from May), the downturn doesn’t yet seem to have hit real estate investment, which by my calculations was rising at about the same rate in June as the average for the first half of the year. Until there’s a drop off in investment I think it’s going to be tough to sell a relaxation of policy.

Even then, the real challenge is to break the current binary situation in the property market, where sales are either feverish or non-existent. To me this suggests policy may have to be kept tighter for longer than many currently suspect - having a real estate policy that swings every six months is frankly worse than not having one at all. Worryingly, I’m not confident that the government will have the nerve to do this. Export growth is set to slow sharply in the next 18 months as the rest of the world tightens fiscal policies, just the domestic economy is cooling as a result of the housing cycle and the easing of the infrastructure investment boom. This all sounds a little bit like 2008-lite, and we all know how policymakers responded then.

Duncan Innes-Ker is a senior economist with the Economist Intelligence Unit

GDP, Guest contributor, Investment, Property, Statistics

When will China raise interest rates?  That, alongside the question of the exchange rate, is the key focus for market attention.  In the view of Fudan University economics professor Sun Lijian, now is not the time.  This is my translation of the main points from his recent blog posting:

‘Today, China is faced with the problems of imported inflation from high commodity prices and a bubble in the property sector.  That is a similar situation to the one we faced in the second half of 2007 and first half of 2008.  Back then, academic and government economists were united in calling for higher interest rates.  What is the difference now?

First, the real economy is growing fast, but it’s a feverish, not a healthy growth.  With the real economy still in recovery phase, using the blunt instrument of interest rates to raise the cost of capital might actually have the impact of forcing capital out of the real economy and into the capital markets - making the property bubble worse.  Quantitative measures - like the reserve requirement ratio - are the best way to clamp down on asset price bubbles without impacting the recovery in the real economy.

Secondly, raising interest rates would not be interpreted by the markets simply as a tightening of monetary policy, but rather be seen as a withdrawal of the stimulus.  If panic gripped the markets, the good work of the twin fiscal and monetary stimulus might be undone.  At the same time, by increasing the interest rate differential with the USA, raising rates might attract hot money inflows, putting more pressure on the currency to appreciate.

Third, for Asian countries - Thailand, Korea, Indonesia - the problem is containing property bubbles caused by rapid inflows of capital.  Containing inflationary pressure and asset bubbles resulting from capital inflows is the most important economic problem facing Asian governments, including China.  Raising rates would attract more capital inflows and make that job more difficult.

Summing up, the risks to the real economy, worsening asset price bubbles, putting more pressure on the exchange rate, and attracting capital inflows suggest that the government should focus first on the use of quantitative tools (the reserve requirement ratio, lending guidance to banks), and that the time for raising interest rates is not yet right.’

You can see the original here.

Exchange rate, Financial Crisis, Monetary Policy, Property

Yesterday I spoke at Macquarie’s China conference, on a panel with He Liping of Beijing Normal University and Zhang Ming of the Chinese Academy of Social Science, moderated by Paul Cavey who is Macquarie’s China economist.

He Liping’s comments focussed on the March trade deficit, which was the first for several years and conveniently timed to head of complaints from trade partners about the exchange rate.  He made the comment that cyclical rather than structural factors explained the slide into deficit, which he expects to be a one off. 

He thought that one of the biggest risks to the growth outlook was a fall in consumption of automobiles.  Apparently there was already evidence that growth in auto consumption is slowing, with inventory piling up in dealers showrooms.  If growth slows, then one of the major supports to domestic consumption will be taken away.

Zhang Ming followed up with some broader comments on the outlook for the Chinese economy.  He noted that last year’s massive increase in new lending, combined with renewed inflows of hot money, has laid the basis for a return of inflation.  He expected the CPI to push up to 4% in July and August of this year.

A 4% increase in prices would be beyond the government’s target of 3% for the year, and Zhang expects a response from the government in tightening monetary policy.  He expects a first rate hike in the third quarter, and 2 or 3 hikes over the course of the year, taking the deposit interest rate up 100 basis points in total.

Zhang noted that the government had already moved against house prices.  He said that transaction volume in residential property markets has already fallen and he expected prices to start to come down.  The situation today is similar to that in the first quarter of 2008.  The danger for the government is that a collapse in house prices might precipitate an end to investment in the sector - which would have a serious impact on GDP growth.

Zhang also spoke on the introduction of a property tax - which the government has begun piloting in several cities.  He thought that introducing a tax would be extremely difficult.  Even though a tax would mean a steady flow of revenue for local government, local government officials preferred the massive slugs of cash they received from land sales.  This is because with a short tenure in any particular location, local officials want to increase revenue fast in the years when they can enjoy it, not have a dependable stream of income for the years after they had moved to a new post.

Fiscal Policy, Monetary Policy, Property

China’s sudden rise invites comparisons with the equally abrupt arrival of its near neighbour Japan on the world scene a few decades ago.  China’s leaders also like to draw lessons from the economic mismanagement of Japan, which has resulted in a lost decade of torpid growth.  In particular, China’s leaders like to point at the problems caused by Japan’s revaluation of the yen, as part of their argument against revaluing the yuan.

But exchange rates are not the only point of comparison between China and Japan.  A cartoon doing the rounds on the Chinese internet invites comparison between the Japanese property sector of the 1980s and the Chinese property sector of today. 

The diagram gives a stylised history of the collapse of the Japanese property sector:

1985 - the Japanese yen appreciated

1986 - speculative capital started flowing into Japan

1987 - house prices had tripled in value (it doesn’t say from what level)

1988 - property prices collapsed but were supported by real estate moghuls

1991 - property prices fell again, there was no one to support them, and the real estate sector collapsed.

The author of the diagram suggests that the Chinese property sector is going through the same process: appreciation of the yuan in 2005, hot money inflows in 2006, sharp rises in property prices in 2007, a fall in prices halted by intervention by real estate developers in 2008, and set for a total collapse in 2011.

Property prices in China are certainly high, and much higher as a multiple of average income than in the US and EU, or even other emerging market economies.  With property prices out of line with fundamentals there’s a risk of a correction, and perhaps a sharp correction.  But I am not sure the comparison with Japan is necessarily the best one to make.  China today is still a developing country with a low level of urbanisation.  Rising incomes and a continual shift of the  from the countryside into the cities will underpin demand for property.  Japan in the 1980s was already a developed and urbanised country, so the property sector could rely on neither of these supports.

You can see the original cartoon here.

Exchange rate, Property

Property prices are the hot topic in China right now.  With the average house price up 10.7% yoy in February and house prices in some areas of the country rising much faster, the government has promised to step in to control the market.  But action has been slow to follow words, and some netizens have evidently concluded that the government is dragging its feet.

One enterprising blogger has pasted together several pictures of Premier Wen Jiabao and added some comical text to capture the Premier’s thought process on how to control runaway property prices.  The pictures show Premier Wen holding up first one, then two, three, four, five and six fingers, presumably to enumerate the six points of an argument he is making.  Underneath the pictures, the blogger has Wen saying:

‘I’m very distressed, at CNY10,000 per square meter, how can ordinary people afford to buy a home?

Now there are even some areas where the price is CNY20,000 per square meter, that’s just unreasonable!

What?  Hangzhou prices have hit CNY30,000?

No! CNY40,000? House prices that high are not natural!

Wow!  Do we really have house prices at CNY50,000?

Well, if they are already that high, we’ll wait till they get to CNY60,000, then introduce some controls.’

I think there might be some cleaning up of this particular joke, but I found a copy of it here (you have to scroll down a bit to get to it)

Culture, Property

How serious a problem is China’s property bubble?  King of the China bears Andy Xie thinks its pretty serious, and on Friday I had the chance to hear him presenting his views.  The main points from the presentation are:

‘The Chinese response to the financial crisis has followed that of the US.  But where in the US a financial meltdown required near zero interest rates to keep the banking system solvent, in China there was no problem with the stability of the financial system.  Very low interest rates were inappropriate for the Chinese economy.  With the Chinese banks motivated to lend to appease their shareholders in Hong Kong, and the property sector motivated to borrow by very cheap rates, a year and a half of very relaxed monetary policy have made the Chinese property sector bubble bigger.

Property in China is a government business.  Many property sector developers are owned by local government.  For those that are not, the cost of land and taxes are so high that they are effectively just middle men for the government.  Property is the most important source of government revenue

The government is caught in a vicious cycle.  Property prices rise, which means that property developers demand more land to build on.  To meet that demand for land, local government has to clear residents away from more and more areas.  Residents see that to buy a new home, they will need large amounts of money.  They demand huge amounts of compensation - Xie mentioned a household in Shanghai that received CNY1mln compensation for being forced to leave a 10 metre square apartment.  The government is now massively in debt as a result of the high cost of compensation, and so needs to sell the land on at high prices to recoup its costs.  Property developers buy the land at high prices, and so can only turn a profit by selling high end property at high prices, and the cycle continues.

Land is now so expensive that only state owned enterprises, that face no real budget constraint, are willing to buy.  With state owned enterprises the only buyer, the property sector is just a series of transfers between different parts of the government.  State owned banks lend money to state owned enterprises who use it to buy land from the state. 

Local governments are waiting for private sector property developers to buy land.  Their attitude is that private property developers only exist with their approval, so their money is really government money, and can be extracted at will.  Private property developers might look big and powerful, but according to Xie they are being squeezed by the government, with profit margins of 50% a few years ago, 25% today, and non-existent if developers are forced to buy land at today’s high prices.

This state of affairs can’t continue for much longer.  In Hong Kong, property is expensive but other taxes are low.  In China, property is expensive and other taxes are high.  The middle class - grauates of the 1990s who are now earning CNY10-15K/month - are getting squeezed.  This is the most able and vocal of China’s social groups.  Xie pointed out that journalists are also in this group, which is why there is so much negative press attention on the housing issue.

Inflation will be the pin that pricks the bubble.  Xie believes that China is entering an age of high inflation.  Xie pointed out that in the 1950’s, Chaiman Mao encouraged families to have multiple children to boost the Chinese population.  ’Hero mothers’ that had 10 children could even meet Mao.  In the 1970s, the children of the resulting baby boom hit their teenage years.  The result was the cultural revolution.  In the 1990s, they entered the labour market and excess labour supply kept wages (and inflation) low.  Now they are leaving the labour market, wages will start to rise and with them inflation. When inflation returns, the Chinese government will be forced to raise interest rates.  When borrowing becomes more expensive, house prices at today’s high levels will not be sustainable, and there will be a sharp correction.  Xie’s intuition is that this will come in 2012.’

Interesting stuff.  I had not heard the argument about compensation for relocation before, and don’t think it is as important as an explanation for high land prices as local government’s need to close the gap in their finances.  But in general, a compelling account of the drivers and motivations of the key players in the most important sector of the Chinese economy.  Also fascinating argument about the role of demographics and Mao’s ‘hero mothers’ in China’s recent social and economic history.

Banking, Financial Crisis, Fiscal Policy, History, Labour markets, Monetary Policy, Property, Social Policy

Local government debt is back in the headlines.  Today, I attended a presentation by Prof Victor Shih, who has just finished some fairly extensive research on the debt taken on by local government investment entities.

The starting point for Prof Shih’s argument is that last year’s massive economic stimulus was massively underfunded by the central government.  Local governments were left with colossal spending obligations but no obvious way to pay for them.  The solution for many local governments was to set up local government investment entities to borrow the money on their behalf.

The process is quite simple.  Local governments set up a financial company and give it some land.  Using the land as collateral, the financial company, which is wholly owned by the local government, borrows money form the banks.  That money is used to fund local government’s investment projects.

Prof Shih’s calculations suggest that money owed by these finance vehicles now adds up to around CNY11trln - or about 1/3 of Chinese GDP.

This money will now have to be paid back.  If, as seems likely, the revenue stream from the projects in which it has been invested are not sufficient, some other way will have to be found.  Land sales, higher taxes, or reliance on a bail out from the central government are the most likely options.

The government might have kept the majority of economic stimulus spending off balance sheet, but the bill will still have to paid.

Chinese economists are also alive to the problem of local government debt.  These are the main points from a recent blog post by Guo Tianyong:

‘Many of the projects funded through local investment vehicles are not commercially viable.  A visit to local areas revealed projects that will not generate revenue for 5 or even 10 years.

That will mean that responsibility for repayment falls back at the door of local government, which has acted as guarantor of the loans.

If the real estate market wobbles and land prices fall, the repayment ability of local government will also come into question.

Properly understood, local government finance risk and bank credit risk are now two sides of the same coin.

A more sensible approach for the future would be for local government to invite bids from the private sector to build local infrastructure.  If projects are commercially viable, there should be no problem.  If the project fails, the private sector is left with the debt, and its no burden for the government.’

You can see Guo Tianyong’s blog post here.  Prof Shih’s research has been getting a lot of play and you can see a summary of it here.

Banking, Financial Crisis, Fiscal Policy, Infrastructure, Property, Regional

I Just finished reading an article in the official magazine Liaowang on the growing wealth of China’s super-rich, the sources of their fortunes, and the social implications of a  widening divide between the haves and the have nots.  This is my translation of the main points:

‘Mr Chen sits in his CNY200,000 chair in his CNY12m house on a fashionable street in Beijing.  This is not Mr Chen’s primary residence, but rather a home he keeps for meetings with business associates and officials.  He points to antique carvings of dragons that line the walls.  ‘I’m not an expert collector’ he says, ‘I just think they are good fun.’

Mr Chen and his type, the company directors, high level managers, and professional investors who form China’s super-rich, have attracted increasing attention in recent years.  In the West, the economic crisis of the last year eroded the wealth of the super rich, but in China this group has seen their wealth increase over the course of the crisis.

According to Forbes, in 2009 the threshold to enter the list of the 400 richest people in China was CNY2.05bn, up from CNY1.22bn in 2008, and 40 people had personal wealth of CNY7bn, up from 24 people in 2008.

China’s super-rich are concentrated on China’s East coast, especially in Beijing, Guangdong, Shanghai, Zhejiang and Jiangsu - where around 60% of China’s richest individuals live.

For China’s super-rich, the road to riches was bright and clear.  The most important route is the real estate market, with the capital market in second place.  In the US, according to Forbes, there are just 50 real estate moghuls amongst the 400 richest names in the country.  In China, that number is 154. Of China’s richest 10 individuals, 5 are involved in real estate.

Hu Run, an expert in China’s rich-list, says that in China the real estate sector surpasses manufacturing, finance, and investment as the way to the top.  Hu notes that China’s special system for controlling land rights, and the rapid pace of urbanisation explain why fortunes can be made in the real estate sector.

Becoming rich in China can also happen more quickly than in the US.  According to Hu, in China the average age of individuals with a net worth of CNY10m is just 39, and of individuals commanding CNY1bn, 43 - much younger than overseas.

In one way, getting rich quick is a sign of the vibrancy of the Chinese economy.  But in another, it points to iniquities in the Chinese economy.  One financial adviser with whom we spoke said that the super-rich clients with whom he worked typically fell into one of three categories: 1) those who relied on power to amass wealth 2) those who had ‘grey’ sources of income and 3) mining magnates and people with monopoly control over a sector of the economy.  He estimated that only about 30% of the super-rich has achieved their wealth through hard work.

The excessive concentration of wealth is an early warning signal of broader problems with the distribution of resources in a society.  Zhejiang Academy of Social Science Professor Yang Jianhua has been researching this question for 10-years.

Prof Yang notes that the experience of other countries is that in the process of development, income distribution gets worse before it gets better.  Specifically, in the income range of USD1000-3000/capita income distribution becomes more unequal, after annual income/capita exceeds USD3000 distribution starts to become more equal.  But the situation in China defies this pattern.

Prof Yang’s research into the distribution of income in Zhejiang shows that even though annual income has now reached USD6000/capita, the gap between rich and poor has not started to narrow, and in fact continues to widen.  Prof Yang notes that the distribution of income in China today does not resemble a pyramid, with a broad base narrowing gradually toward a peak, but rather an inverted ‘T’ with a massive base of people struggling to get by, and a tiny tip of people who control a disproportionate amount of wealth.

One scholar, who was not willing to reveal his name, said that today there were a growing number of cases where government officials, their families or agents controlled access to resources and used them to generate personal wealth.  This conversion of public power into private wealth is a new challenge for the anti-corruption authorities.

China’s new rich do not appear to have strong social or charitable convictions.  One financial advisor with whom we spoke said that many of the super-rich were desparately seeking government offiice, but they did so only as a means to amass more wealth or protect their interests. ‘They don’t believe in duty, only in money’ he said.’

By coincidence, I just finished reading ‘China’s Trapped Transition’ by Minxin Pei.  There is a lot in this article which resonates with Pei’s bleak vision of today’s China:

-The monopoly control of economic rents by those with political power

-An accelerating effort by this privileged group to turn their power into wealth, indicating a lack of faith in the future and an attempt to cash in as quickly as possible

-A collapse in the ideological values which might provide a check on the abuse of power

You can see the original article here.

Communist Party, Financial Crisis, Property, Social Policy