1. Lujiazui Forum Sent an Important Policy Signal

Since June of this year, the Chinese government has sent many new signals on its real estate policy, particularly real estate financial policy. The implications of such policy signals warrant our attention.

The policy signals were fully released at the Lujiazui Financial Forum in June. “In recent years, some cities in China saw a steep rise in the household leverage ratio, and a large proportion of households reached an unsustainable level of indebtedness,” said Guo Shuqing, Chairman of the China Banking and Insurance Regulatory Commission (CBIRC), sternly, “to make things worse, around half of new savings went into the real estate sector. Apart from competing for credit resources with other sectors, excessive financing for real estate stokes real estate investment and speculation, giving rise to bubbles.” “History has proven that countries over-reliant on real estate to achieve and maintain economic prosperity all ended up paying a heavy price,” stressed Guo.

This message is of great importance for the following reasons:

First, the household sector’s indebtedness has become unsustainable. The implication is that future policymaking will strive to deleverage the household sector, or at least prevent the household leverage ratio from continuing to rise. The upward cycle of China’s real estate market since 2015 owes to increasing household leverage ratio. Household deleveraging will have obvious implications for the real estate market.

Second, the real estate market has occupied an outsize share of credit resources. The implication is that mortgage and development loans will come under tighter scrutiny.

Third, the economy should wean from overreliance on the real estate market.

Notably, Vice Premier Liu He, who is in charge of economic work, illustrated China’s macro-leverage ratio since the 19th CPC National Congress in 2017 with charts and figures at the forum. He presented three curves indicating the household, corporate, and government leverage ratios. While corporate leverage ratio has dipped and government leverage ratio nudged down, the household leverage ratio has spiked. “There are very complex structural and institutional factors behind this rising curve,” he noted, “we need to unravel the causes and take effective countermeasures.”

Liu’s speeches can be summed up with the following three highlights:

First, the decision-makers attach great importance to the rising household leverage ratio as a significant challenge to China’s economy.

Second, real estate is chiefly to blame for the spike in personal debts.

Third, senior leadership has decided to take action to address the excessive rise in the personal leverage ratio.

Both Guo and Liu mentioned real estate and household debt issues in their respective speeches, which is not by coincidence. The implication is that decision-makers have come to agree on the policy orientation of real estate. At least from official statements, China’s real estate policy orientation swerved in June. The CPC Central Committee Politburo meeting at the end of July has reaffirmed such a shift: After repeating the message that “housing is for living in, not for speculation” and calling for implementing the long-term mechanism for real estate regulation, the Politburo meeting has released a new statement: “We should not use real estate as a short-term means for stimulating the economy.”

2. What Led to the Shift in the Real Estate Policy?

Beyond doubt, China’s real estate policy has swerved. The questions are what are the reasons behind such a shift? Is it a short-term or long-term shift? To answer these questions, we must unravel the underlying reasons behind China’s changing real estate policy.

First, let us look at the relationship between real estate investment and China’s macroeconomic performance. The red curve shows the annual growth of manufacturing investment. The blue curve denotes yearly GDP growth. The green curve is the annual growth of real estate investment.

From a long-term perspective, the three curves are highly positively correlated. As can be seen from a few time points, China’s real estate stimulation in 2009 effectively led to a rebound in both GDP and manufacturing growth rates. After peaking in 2010, the three curves simultaneously dipped at the end of 2014 and early 2015 almost in parallel.

The divergence occurred after 2015. In early 2015, real estate investment growth approached zero, but swiftly rebounded under the effect of a host of stimulus policies, particularly policies that led to an increase in the household leverage ratio. At the end of 2018, real estate investment growth exceeded 10%. However, the other two curves did not rebound with rising real estate investment. In particular, GDP growth kept on the decline.

As can be seen from the chart, the relationship between the three curves started to change before 2015. Unlike in the past, the policy stimulus to shore up real estate investment failed to bring about an uptick in China’s economy. The divergence in the correlation of the three curves is attributable to the fact that real estate investment has lost its potency in propping up growth, so much so that the government no longer needs to resort to real estate to spur a slowing economy.

Here, I would like to cite the information from Professor Ni Pengfei at the National Academy of Economic Strategy, CASS to illustrate the underlying reasons behind this phenomenon.

The first chart shows the real estate industry’s effects of stimulating and crowding-out consumption. Rising housing prices may boost and crowd out consumption at the same time; these effects vary with the housing-price-to-income ratio. The left column is the housing-price-to-income ratio, and the right column is the ratio between stimulation effect and crowding-out effect. As the table shows, when the housing-price-to-income ratio is 2, the consumption stimulation effect is 13.98 times that of the crowding-out effect. Lower housing-price-to-income ratio corresponds to a more significant consumption stimulation effect of rising housing prices. As the housing-price-to-income ratio increases, the ratio between growth stimulation effect and crowding-out effect will change as well.

The second table shows the stimulation and crowding-out effects of real estate investment on aggregate investment. When the housing-price-to-income ratio exceeds 11 times, the stimulation effect of real estate investment would be smaller than the crowding-out effect.

Based on the above two tables, it can be concluded that when the housing-price-to-income ratio is 9, the GDP stimulation and crowding-out effects of real estate investment on consumption are about the same. When the housing-price-to-income ratio exceeds 9, the negative economic growth effect of real estate investment outweighs the positive effect. In other words, when the housing-price-to-income is above 9 times, real estate investment will contribute negatively to the economy. By the end of 2018, China’s overall housing-price-to-income ratio stood at 9.1 times, which is highly consistent with the observed macroeconomic phenomenon. Given the complex relationship between real estate and the economy, this finding warrants further research and attention, but at least offers a clue for analysis on the impact of real estate investment.

3. Outlook on the Real Estate Policy

Based on the above analysis, our outlook on future real estate policy can be divided into the following two parts:

First, China’s real estate policy should tighten on all fronts in the short run. China should tighten mortgage loans by raising interest rates; bring real estate development loans under tighter control; offer window guidance on bond issuance by real estate firms by introducing a blacklist system; tighten overseas bond issuance by restricting the borrowing of new loans to repay existing loans; curb the flow of trust funds into the real estate sector (CBIRC No.23 Document); some large real estate developers are likely to default on debts, exposing their negative externalities and triggering a regulatory storm.

Second, China should restructure its institutional systems in the medium- and long-term, such as redesigning the housing system, restructuring the land system by amending the Land Administration Law, and overhauling its fiscal system. The amendment to the Land Administration Law implies a revolutionary change in the legal premise that underpins the real estate industry. After the housing reform of 1998, China’s real estate industry took another important shift with the amendment to the Land Administration Law in 2019. As local governments wean from land sales revenues, fiscal restructuring becomes inevitable.