fter launching various policies to encourage sales of unsold real estate inventory in an effort to boost investment and stimulate the economy, the Chinese government appears to be faced with a policy dilemma. Not only has the stimulus package further inflated already sky-high property prices in China’s megacities, it has also proven ineffective in smaller third-tier and fourth-tier cities – the very areas suffering most from housing gluts.
The fundamental problem with the distortion of value in China’s housing market lies in an excessive leverage ratio. Taking advantage of the recent stimulus policies, including tax breaks and loosened payment requirements, has allowed some financial institutions to offer products such as “zero down payment ” purchases and “down payment loans” to home buyers, effectively allowing them to purchase way beyond their means. As the housing market in megacities offers better liquidity and higher yields, capital tends to flow into these more volatile real estate markets, rather than into more affordable housing stock in the provinces.
Economists are now warning that if this trend of liberalization continues, it could trigger the collapse of China’s already overheated housing market, causing a major financial crisis. As housing prices continue to rise, ordinary people will be pushed further out of the housing market, posing a real threat to political stability, given the priority attached to home ownership in Chinese society.
To address the problem, the authorities must take swift action to curb the excessive leverage in the housing market. First, the government should strengthen regulation of the financial sector. With the development of financial innovations such as Internet financing through peer-to-peer platforms, various financial institutions previously excluded from the housing market have found a way in. The authorities must beef up their ability to monitor and respond to a changing financial sector.
Second, the government should establish an effective national personal credit information system, so that financial institutions can obtain adequate information on clients’ financial situations. Such a system would also serve to give an overview of the general health of the financial sector.
Third, in its overall strategy, the government must take a more cautious approach in using financial leverage to stimulate the economy. To some extent, China’s rapid economic growth has been made possible by such leveraging. An instinctive response at the local level to the recent economic slowdown has been to further increase financial leverage to stimulate the economy.
However, the authorities must be aware of the risks associated with excessive leveraging.
Misusing unregulated financial leverage to stimulate the economy is like swallowing poison to cure a disease. The author is an economist with the China National Gold Group Corporation.