Putting China’s house in order

A slowdown in home construction is a big drag on China’s economy, with GDP growth down to a six-year low of 7%. The government is struggling to arrest the slide.

A slowdown in home construction is a big drag on China’s economy, with GDP growth down to a six-year low of 7%. The government is struggling to arrest the slide.

A barrage of stimulus measures this year, including five interest-rate cuts since November and relaxed house-purchasing rules, have boosted sales in recent months.

However government stimulus is failing to offset the overhang of inventory from previous years. The backlog is so bloated, particularly in China’s third- and fourth-tier cities, that property developers are largely unwilling to acquire land and start new projects.

Rate cuts have been less effective than usual due to the property sector’s indebtedness, which makes developers’ investment agendas less responsive to policy changes.

China’s leadership has ruled out a return to 2008-style bazooka stimulus, which would prompt further renminbi depreciation. This is prudent, but it leaves Beijing pursuing more-of-the-same incremental reforms and gradual rate cuts. The reform effort touted over the past several years needs to be pursued with the sort of zeal that once marked the government-led credit boom.

In the meantime, China’s efforts are just cushioning the slowdown, not turning the business cycle, as we will see when third-quarter GDP numbers are released. Property investment growth will continue to fall and might turn negative next year for the first time since 1997, according to economists at brokerage Nomura. Restructuring requires painful political choices, but not restructuring delivers its own kind of hurt.

And hurt it will: home construction generated 10% of GDP in 2014, and it has a knock-on impact on a whole swathe of heavy industry, from steel to cement, equating to roughly 30% of GDP.

China has depended too much and too long on investment into residential property to prop up growth.

No other major economy has maintained home construction above 10% of GDP. In Ireland and Spain, when construction levels edged above 10%, a dramatic bust quickly followed. Lessons from other economies suggest 6% to 8% of GDP is sustainable, say researchers at Barclays.

If China is to avoid the destabilizing contraction in construction the US and Japan experienced after a bust it should hasten its rebalancing towards services, which continue to grow.

If consumption were to fill the gap in demand left by the normalization of residential investment, it would have to grow about 1.5% per year faster than GDP. This seems unlikely without more supportive policy measures designed to promote consumption demand and continued efforts to allocate capital via markets rather than by state fiat.

The unwinding could take years but will put the economy on a more sustainable footing.
 

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