Chinese growth and the property bubble

China’s residential property bubble is helping to sustain economic growth, while increasingly frustrating Chinese citizens. Reforms to taxation arrangements are required, but unlikely in the near term, Xinling Wang writes.

In the lead-up to the 19th Party Congress, the Communist Party of China has shown increased tolerance for slower economic growth. Seeking a soft landing for its over-bloated housing market, there is growing momentum against property speculation, a consistent driver of economic expansion in China.

Although doing nothing is no longer affordable, sticking this soft landing will be tricky. Miscalculation could burst the bubble, dragging down the economy. The test for the Party will likely come next year, if economic growth, as expected, continues to slow.

In December, a statement from the Central Leading Group on Finance and Economic Affairs, on which Xi Jinping sits, gave hints on policy direction: ‘Houses are built for living, not for speculation.’ This was the fourth time the housing bubble was mentioned by Chinese leaders in the second half of 2016. President Xi is rallying an increasingly frustrated public against speculators, developers, local governments and real estate agents, who benefit from, and contribute to, inflated residential property prices.

For the public, booming property prices are pushing a growing number of young people out of the housing market, and the cohort of first-time homeowners is growing older.

A campaign against speculation is also needed to dampen (if not reverse) the prevailing expectation that prices will always rise. This encourages speculators and desperate buyers to take out larger loans, potentially posing a threat to the banking system.

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President Xi’s campaigns seem to be also inspiring some reform-minded bureaucrats. A formal and long-awaited policy on housing bubbles is due out this year. While it will take time to fully develop and implement, the long-term measures of the policy will aim to find solutions to the profound problems in the financial, fiscal, legal, housing, and land institutions that influence the property market.

A number of policy options are being considered.

First, a rental market, protected by legislation, that guarantees tenants the same access to social benefits as homeowners. Access to public schools is crucial, as education of their children is the biggest concern of young urbanites. However, legislation itself is far from sufficient, as unequal access is deeply rooted in the scarcity of public education resources, which will take time and funds to improve. Another current move is developing cheaper public housing, where leases could be converted to ownership when tenants are in a position to purchase their dwellings.

At the core of the housing bubble lies ‘land finance,’ a system with complex and deep roots in fiscal, financial, land and rural institutions. Land finance refers to the practice where both local government and developers use land as collateral to secure loans from banks. Despite the shadowy nature of such endeavours, they have been tolerated as a reliable source of local government revenue. After all, when growth dictates all, policies that support investment will prevail.

Depending on its monopoly power, local authorities could take land from peasants then sell to developers. Charging developers a land transfer fee, a major component of land finance, local governments would then pocket the value added to land following development. Developers would take land to banks to borrow money to build homes, only paying back debts when homes are sold. Behind the decades-long housing boom in China, this simple formula has rarely failed. Developers and banks know homes would be sold, with buyers willing to pay inflated costs, expecting prices to rise further.

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An option to replace land finance with a property tax, paid by homeowners, is also being considered. While easy to collect on developers, the land transfer fee is eventually passed down to buyers, twisting tax incentives.

However, with home prices already so high, many homeowners are against a property tax. The Property Tax Law has been repeatedly delayed, with 2020 being the earliest expectation for implementation. Despite the difficulties, a practical approach is needed, allowing the government to impose a property tax without causing sell-offs and thus sharp corrections. Yet because of these difficulties, a transitional plan from land transfer fees to property tax is not in sight.

The unexpected growth rate in the first half of 2017 is mostly supported by a continued housing boom. As the government continues to clamp down on real estate in overheated cities, the delayed economic slowdown effect may emerge in late 2017 and early 2018.

By then, government action on the housing bubble would send an assuring message that it prefers healthier, albeit slower, economic growth.