Friday 29 Mar 2024
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SINGAPORE (June 12): The property bubble in China is expanding as home prices in tier-1 cities reach dangerously high levels, raising concerns at a time when corporate debt and capital outflows are also rising.

Property prices in Shanghai are up by 50% this year versus 2015, to levels similar to those in Manhattan and Hong Kong.

“The biggest risk for China this year is the implosion of the property bubble, which would result in a sharp drop in prices and sales at a time when the economy is still slowing down,” says Nomura economist Yang Zhao.

The way Yang sees it, the pace at which property prices are rising could soon become unsustainable as fewer investors are able to afford real estate. That would eventually to a collapse in prices and a sharp slowdown in growth.

“Growth is already slowing in China, as the government continues with structural reforms,” says Yang.

More importantly, investments in the property sector have helped steel and construction companies to stay alive and prop up the economy over the short term.

Should the bubble burst, China’s GDP could fall below 5%, leading to massive corporate defaults and job cuts, says Yang. The Chinese economy grew 6.8% in 2015.

Lower rates

To keep the property sector above water and ensure property owners and investors are still able to pay their loans, the Peoples’ Bank of China must keep interest rates low, says Yang.

“The PBOC needs to keep funding costs low to keep investments in the property sector sustainable,” says Yang, who is expecting another rate cut in Q3.

But wouldn’t that also encourage credit expansion and fuel the property bubble further?

Yang reckons it is the lesser of two evils. On one hand, lower rates would spur more property investments and drive prices up further. It could also lead to the build-up of other asset bubbles.

On the other hand, it would also reduce the finance costs for the private sector, which has racked up debts amounting to 180% of total GDP, and help corporations deleverage.

Capital outflows

In addition, limiting the number of defaults in China’s private sector is important to prevent nervous investors from pulling out funds en masse from the Chinese equity market.

That, in turn, helps keep the value of the renminbi stable at a time when capital outflows are accelerating as markets prepare for an imminent US rate hike.

China’s foreign exchange reserves fell below US$3.2 trillion in May for the first time since December 2011, after stabilising in March and April.

As such, Yang reckons lower interest rates are key to helping China navigate its way through slower growth and rising volatility in the equity and currency markets.

“We still need the property market to grow and consumption to rise to help boost short term GDP, while the corporate sector deleverages and supply-side reforms continue,” he says.

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