s China’s housing market building up a bubble rivaling that of Japan’s in the late ’80s, or the US’s before 2007? Will China’s debts implode and foreign exchange reserves hemorrhage? Will there be more massive job losses because of efforts to take on overcapacity? These are the hypotheticals that Chinese and international observers and investors can’t stop discussing, and exactly the ones that China’s policymakers are trying to avoid.
A “good reserve of policy instruments” in China’s “toolkit” will tackle internal and external risks in order to achieve China’s growth target this year, Chinese Premier Li Keqiang said at a press conference on March 16. He spoke shortly after the conclusion of this year’s Two Sessions, the annual meetings of China’s top legislative body, the National People’s Congress (NPC), as well as the country’s political advisory body, the Chinese People’s Political Consultative Conference. During the two-week NPC session, ministers of Li’s cabinet pledged to stabilize the housing market, relieve debts and overcapacity, and encourage innovation and entrepreneurship to secure the pace and quality of growth both this year and over the next five. The goal is to build a “moderately prosperous society” by 2020, an ambition set out in the government’s 13th Five-year Plan (2016-2020), which was approved by the NPC during the Two Sessions.
It appears that the implementation of market- driven reform has recently been nudged higher up the central government’s agenda than ever before. This reform will test the resolution and skill of its designers. The biggest challenge its architects face is that the market does not necessarily do as it is told.
Pressure Points With US$1 million, you can buy 46 square meters of real estate in prime locations in Shanghai, or 58 in Beijing, respectively ranked eighth and 10th on a list of world cities with the highest property prices in 2015, according to a March 2 report published by real estate firms Knight Frank Residential and Douglas Elliman. Those 2015 figures are already significantly outdated because housing prices in China’s biggest cities have rocketed since the beginning of the year. A new, more worrying phenomenon is that various methods of financial finagling have helped underfinanced households in those cities to circumvent the minimum down payment requirement. As NPC delegate and mayor of southwestern China’s Chongqing municipality Huang Qifan warned during the meetings, zero down payment mortgages and soaring property prices were exactly the recipe that produced the US subprime mortgage crisis that hit in 2007.
Meanwhile, less developed provinces and smaller cities, where 70 percent of China’s 739 million square meters of unsold real estate inventory is located, had to hand out subsidies to attract buyers. Despite this, the country’s National Bureau of Statistics released data showing that in January and February, housing prices in these areas lagged even further behind those in big, booming cities. The gap has been widening since property investment in China slowed down significantly in 2014 and saw nearly no growth in 2015.
Taxes and fees for developed land were once local governments’ main cash cows.
Since 2009, many local governments have borrowed huge sums of money from banks via the obscure operations of financing platforms, deluded by the fantasy of an everlasting property boom. An investigation by the NPC found accounts of contingent debts were somewhat murky. Methods of debt accumulation, as well as its breakneck pace, have become one of the two most worrying predicaments keeping analysts and China’s policymakers up at night. The other is China’s corporate debts. The country’s corporate debt-to-GDP ratio is staggeringly higher than those of the US, the UK and the average among G20 states.
Much of this borrowed money was spent on inefficient production, causing overcapacity.
As a part of the renewed efforts to deal with this phenomenon, about 1.8 million workers in the steel and coal industries, mainly in State-owned enterprises (SOEs) heavy with debt, will lose their jobs in 2016.
This process will possibly involve writing off bad loans on banks’ balance sheets due to the shutdown of factories and increased public spending on relocating laid-off workers in order to avoid social unrest.
Behind this debt buildup and the bank loans that supported the property boom is China’s huge supply of money that it has kept on the market for the past few years. China will relax its monetary policy further in 2016 to prop up growth. However, China’s foreign exchange reserves, the main source of China’s money supply, have fallen by US$790 billion as of February, having peaked in June 2014.
There is concern that if this drop was caused by selling foreign exchange reserves to ease the yuan’s sharp depreciation in the context of a recent capital exodus, as widely speculated by the market, the remaining reserves could rapidly be drained.
Separately, none of these issues is a major problem. Nor would they become a major problem in the future as long as the economy keeps growing robustly. However, they are all linked in one way or another, and together they put China’s fiscal and financial strength under a huge amount of stress.
White Knights Specific solutions to each of these problems were announced at the Two Sessions. In regards to the out-of-control housing market, China’s central bank vowed to crack down on the illegal lending practice of funding down payments through real estate and online peer-to-peer platforms. Stricter restrictions on purchasing property and land supply have been announced to help big cities stabilize their housing prices both now and in the future.
At a press conference during the NPC session, Chen Zhenggao, minister of housing and urban-rural development, expressed his “emotional” commitment to getting migrant workers settled in smaller cities where he sees housing markets with great potential. In the past two years, instead of renovating slums, the government has assisted some poorer residents to buy new apartments from developers through lowered prices or government subsidies. This arrangement will be further promoted this year to improve the condition of the property market and reduce unsold real estate inventory, both of which are goals listed in Li Keqiang’s government work report that was released during the Two Sessions.
Many analysts recently found that China’s total debt-to-GDP ratio, well below the average of advanced economies’, is not as high as previously feared, thanks to the robust financial position of China’s households and the central government. While the country’s households are expected to save the housing market, the central government is ready to dig deeper into its own pockets to clear up the mess of local government debts and overcapacity. The 2016 budget plan, approved during the NPC session, has raised the public deficit to a record high of 3 percent of GDP, an international red line. Lou Jiwei, China’s finance minister, explained at a press conference during the NPC session that the additional deficit would be used to address some of the country’s thorniest issues.
About US$15.4 billion or more will be spent in 2016 and 2017 to provide for SOE workers laid off in the new campaign to remove industrial overcapacity. This is to dispel local governments’ core concerns about the social unrest that typically accompanies mass unemployment. For years their resistance towards stopping financial support to so-called “zombie” SOEs has been regarded as one of the major obstacles to solving overcapacity.
Another process racking up a large tab is closing the fiscal revenue gap left by reduced taxes. Easing operational costs is one of the five tasks outlined in the 13th Five-year Plan.
Besides more tax rebates to small businesses and lower corporate contributions to social insurance, a sweeping tax reform involving local taxes will spread to all service sectors, including the property sector, starting May 1.
This reform has already been in a trial phase for two years. As a result, total corporate taxes will be slashed, with local governments the most affected, according to Minister Lou Jiwei.
Joerg Wuttke, president of the European Union Chamber of Commerce in China (EUCCC), said the tax reform and budgeted spending directed toward laid-off SOE workers stood out to him in particular. The EUCCC has been following China’s overcapacity efforts closely since 2009. As Wuttke explained to NewsChina, though European companies do not have a strong presence in those sectors, they regard lingering overcapacity as “damaging” to both China’s economy and the credibility of the Chinese government, and [this affects] their confidence in the Chinese market. He describes the tax reform as a “nanny State’s” warning to its children that in the future they will not be allowed to keep so much money on hand and do whatever they want, like supporting local zombie enterprises. Meanwhile, local governments are allowed to issue bonds regulated by the new budget law, local tax systems will be improved to finance local public services and money is ready to ease unemployment pains in SOEs.
Wuttke said these are encouraging signs.
Naturally Naughty The problems themselves have shown how difficult it is for even very targeted policies to achieve their intended results. For example, in early 2016, while all the restrictions in bigcity housing markets remained in effect, policymakers introduced lower mortgage rates and taxes specifically designed to boost the markets of smaller cities. Contrary to design, those markets plodded forward, while real estate prices in megacities continued to run amok. Heavy debts were mainly built up by local governments and SOEs taking advantage of the big stimulus package introduced in 2008 and 2009 that was meant to cope with the sudden shock of the global financial crisis. Joint campaigns were co-launched by ministries several times over the past 10 years to get rid of outmoded overcapacity and install better facilities. The most recent previous campaign began in 2009. Yet despite these efforts, overcapacity grew. For instance, the country’s crude steel output, the biggest overcapacity culprit, increased by an annual average of 6 percent from 2010 to 2015, according to the Brussels-based World Steel Association. At the same time, China still needed to import high quantities of high-end steel products.
One of the possible explanations behind why these policies are not bringing about their intended effects is that it is often the nature of the market to think differently than policymakers. This is true everywhere. The recent relaxed monetary policy in Japan and Europe that was meant to encourage corporate borrowing has not been successful, as banks are reluctant to offer loans at such low interest rates because that would squeeze their profits. As another example, China changed the way it set the official benchmark for its foreign exchange parity price in mid-August last year in order to give the market a bigger say, yet investors interpreted it as a sign that China’s economy was in worse shape than anticipated and the government was ready to depreciate its currency to boost exports.
Some of these unexpected results are the market’s knee-jerk responses to certain policy tools. Big cities with more jobs and better public services attached to residents’ hukou, or permanent residence permits, are naturally much more attractive to property buyers, driving those cities’ frenzied housing prices.
Favorable policies in the name of supporting innovation have incentivized investors to produce more solar panels than the market demanded. Increased communication with the market by China’s central bank since February and the US Federal Reserve’s decision not to raise interest rates have helped slow down the outflow of capital from China.
Wuttke said the country’s reliance on highend steel imports was a result of quality Chinese steelworks being run out of business by zombie enterprises that ended up wasting financial resources and racing each other to the bottom.
Thus, it is crucial to always think about market forces when choosing which tools should be used. Proposed SOE reform shows why this is so important. In this round of SOE reform, more of these enterprises are being pushed towards mergers and acquisitions instead of bankruptcy. While the Two Sessions convened, reports on workers protesting unpaid wages at Heilongjiang Longmay Mining Holding Group, a State-owned coal giant, attracted both Chinese and international media attention. Just a few days before, Lu Hao, governor of Heilongjiang Province, had told the media at the NPC meetings that such salary issues “did not exist” at Longmay. He later had to promise at a special press conference to arrange reimbursement for the workers’ overdue pay. The Longmay group was a result of the merger of several SOEs at the end of 2004. Longmay’s case demonstrated mergers do not necessarily make more sense than bankruptcy for SOEs, according to a March 16 statement by Zhang Wenkui, a researcher at the Development Research Center of the State Council.
The way policymakers use their tools is as important as choosing the right ones. A man surnamed Zheng had to close his small coal mine in Shanxi Province about 10 years ago, after the local government set a larger capacity standard and his mine no longer complied.
He did not complain, because he was given enough time to transition smoothly out of the industry. However, many of those
who invested a lot in order to meet the new standards were soon forced to close anyway because the government raised the standards once again, this time without any grace period.
Zheng thought many investors could have pulled through by upgrading their equipment if they had been allotted that same transition period. Thus, they could be better prepared for the drastic decrease in coal prices that was to come in the following years, rather than dropping out of the industry en masse and leaving the local economy in a mess. As he told NewsChina, Zheng realized from this experience that policy can have a huge impact on the survival of an entire industry. He saw the importance of a more predictable regulatory framework, one that is not subject to officials’ whims. He said he hopes the government concentrates on social standards and lets investors themselves decide whether or not to invest, based on market demand and legal standards.
Understanding the market is critical for policymakers to work more effectively. For example, there are many national and local industrial funds to support innovation-oriented companies. Wuttke said the government needs to tell those companies that if they fail, they will be on their own. Lu Hao, Heilongjiang’s provincial governor, recognized he had incorrect information regarding the Longmay situation.
Zheng said he believes the unemployment numbers resulting from the national campaign against overcapacity may be much larger than the government is forecasting now, because many contract workers in SOEs are not official employees and thus are less likely to be covered by the current paid relocation plan. The high cost of defending the yuan’s value during short-term market volatility has been controversial. Calls for more open social welfare access for residents without hukou have been growing.
Reform is about constantly trying to improve.
It is worth trying to communicate more with the market and society in order to make the results of reforms match their intentions.