Property Market Nearing a Trough?

CHINA MACRO MONITOR – Property Market Nearing a Trough?

Property Market Nearing a Trough? While some key economic indicators in China took a pause in July from their improving trend of recent months, we believe targeted policy stimulus will drive growth higher though the rest of the year and into 2015.

The domestic equity market has shrugged off the recent batch of weak numbers and the MSCI China A Share index has rallied 10% in the past month.

One of the factors weighing on economic performance recently is weakness in the property sector.

According to IMF calculations, the real estate sector together with construction accounts for 15% of GDP, a quarter of fixed asset investment and 14% of urban employment. The health of the property sector is therefore important to the health of the overall economy.

We believe that the property sector is going through an orderly correction and will near a trough in coming months as the effects of policy stimulus kicks in.

We believe the government has the capacity and the policy conviction to stimulate the property market and the broader economy into 2015.

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ORDERLY PROPERTY MARKET CORRECTION

The Chinese property market is correcting. Price growth has moderated in year-on-year terms and on a month-on-month basis, more cities have reported declines than ever before. We believe the deterioration in July will prompt further policy stimulus that will lead to a turn in the property cycle. The government is determined to see economic growth measured in GDP terms hit 7.5% this year and is unlikely to let a downturn in the property market derail its plans.

Third tier cities suffering the most

The price moderation has been the most pronounced in third tier cities. Residential real estate inventories in third tier cities have increased the most. The oversupply is in part linked to local governments’ reliance on land sales to finance spending (see China Macro Monitor July 2014). Land is more easily available to developers in these cities as governments are keen to monetise their assets. We believe that reform in local government financing will reduce this source of supply over time.

Real estate investment has moderated, but shows signs of stabilisation

Real estate fixed asset investment accounts for about a quarter of total fixed asset investment. While its growth has been moderating, it has stabilised at a relatively high level of over 14% y-o-y over the past three months. According to IMF calculations, a 1% decline in real estate investment could shave off 0.1% of GDP growth in the first year1. China appears to be very far from seeing an actual decline in investment, but we would expect the government to be vigilant against any downturn that would threaten its growth targets. The IMF projects GDP growth of 7.4% this year, with real estate investment growth moderating to 5% y-o-y.

Property sales subdued while potential buyers wait on the side-lines

Potential buyers talking a ‘wait-and-see’ approach have been blamed for the decline in property sales. The pace of urban migration remains robust and pent-up demand to upgrade properties has certainly not fallen. With the threat of the malaise in the property market becoming self-fulfilling, we expect the government to offer further stimulus the break the cycle. Residential property sales had become less negative in June, but slipped further July alongside other measures of economic performance.

Low household leverage and continued urbanisation bode well for medium term property demand

China is little over 50% urbanised, significantly less than other emerging markets such as Brazil and Russia and will continue to urbanise at a strong pace over the coming 20 years. According to the United Nation’s projections, 310 million Chinese citizens (i.e. a population close to the size of the US today) will migrate from the countryside to cities over the next two decades. The Chinese government’s ambitions are even grander – to move close to 400 million people to the cities. That speed and scale of migration is unprecedented in human history. Even though a number of cities appear to be over-supplied with property today, we believe that excess supply will soon be absorbed.

Household indebtedness in China is also low by international standards. The orderly property market correction we foresee in China is unlikely to lead to a systemic problem for households because their financial leverage is relatively small.

We believe that such low level of indebtedness affords the government headroom to loosen house purchase restrictions (HPR) and lending criteria to stimulate the property market. As more Chinese people aspire to become homeowners, we are likely to see household leverage rise over time.

Policy relaxation will provide a tail-wind

In contrast to 2008 and 2011, when the People’s Bank of China cut the reserve requirement ratio (RRR) to stimulate lending activity across the board, recent stimulus has largely been left to local governments and is therefore highly targeted2.

For example, a number of cities have relaxed rules that previously prohibited households from owning more than one property (house purchase restrictions or HPRs). 37 out of 46 cities that had such restrictions have reportedly relaxed to some extent.

Some cities and provinces have announced tax subsidies to spur demand while others have been buying properties that have already been built to add to their pool of social housing.

The PBoC has also asked banks to speed up mortgage approvals and apply ‘reasonable’ pricing, which could quicken the pace of home sales. Anecdotal evidence from media reports point to banks following through on that request.

Changes to the loan-to-deposit ratio (LDR) made in July will also free up banks’ capacity to lend. By reducing the categories of lending that need to be included in the loan component and increasing the number of items that can be included in the deposit component, banks will be able to avoid hitting their LDR limits so easily, allowing them to lend more to prospective home buyers.

To support real estate development, the central government has increased its social housing target to 7 million units of new starts (of which 4.7 million units will come from shanty town renovation). The central government is also leaning on local governments to see that red-tape does not slow the process of fiscal disbursement and planning approvals.

The central government could go further by relaxing Hukou policies, which currently apply laws asymmetrically to migrants from the country and native city dwellers. Easing of these laws, could allow the freer movement of people ratio and cut mortgage interest rates (either as part of an overall cut in rates or independently).

Developers display cautious optimism

The annual decline in floor space started has been narrowing in recent months, in a sign that property developers are becoming more optimistic about future demand. Developers need to plan ahead of the actual turn given the lag between starting development and the actual completion of properties to sell in the market. Nevertheless, if their optimism proves to be timely, we could see the property market trough soon.

CHINA A SHARE SENTIMENT MARKEDLY IMPROVES

Despite the string of weak data in July, including disappointing loan and money supply growth, equity markets rallied. The MSCI China A Share index gained 9.5% last month.

The China A Share market is also likely to benefit from the launch of the Shanghai-Hong Kong Connect, which expected in October 2014 (see Shanghai-Hong Kong Stock Connect: A Boost For China A Shares) . The initiative will open up access to the Shanghai stock market for foreign investors trading through Hong Kong. Systems testing for the initiative will start at the end of this month. We believe that the manner in which the quotas are applied will drive net flows into the mainland. At the moment, dual-listed stocks are trading at approximately an 8% discount on the A shares market compared to the H share market. The introduction of the Shanghai-Hong Kong Connect should see that discount dissipate over time. Valuations of the China A share market indicate that it is cheap. Its prospective PE now stands at 10.2, 63% below its peak in 2007. It is not often that the stock market of one of the world’s largest and fastest growing economies is trading at one of the world’s lowest valuations. The imminent implementation of the Shanghai-Hong Kong Connect programme should help to speed the process of valuation normalisation.

For more information contact:

ETF Securities Research team

ETF Securities (UK) Limited

T +44 (0) 207 448 4336

E info@etfsecurities.com

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When being made within Switzerland, this communication is for the exclusive use by ”Qualified Investors” (within the meaning of Article 10 of Section 3 of the Swiss Collective Investment Schemes Act (”CISA”)) and its circulation among the public is prohibited.

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This communication may contain independent market commentary prepared by ETFS UK based on publicly available information. Although ETFS UK endeavours to ensure the accuracy of the content in this communication, ETFS UK does not warrant or guarantee its accuracy or correctness. Any third party data providers used to source the information in this communication make no warranties or representation of any kind relating to such data. Where ETFS UK has expressed its own opinions related to product or market activity, these views may change. Neither ETFS UK, nor any affiliate, nor any of their respective, officers, directors, partners, or employees accepts any liability whatsoever for any direct or consequential loss arising from any use of this publication or its contents.

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China Growth Picks up as Stimulus Takes Hold

China Growth Picks up as Stimulus Takes Hold. This publication is a new regular report focusing on macro developments in China relevant to investors across asset classes and markets.

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China steps up monetary and fiscal stimulus, marking a key policy turning point

The People’s Bank of China (PBoC) cuts reserve ratios for small and rural banks

Data releases over the past months indicate stimulus policies are starting to have an impact

Structural reform remains high on the policy agenda, but growth takes precedence

China steps up monetary and fiscal stimulus, marking a key policy turning point. Over the past month a number of fiscal and monetary policy initiatives and speeches by senior leaders has made it clear that China will “do whatever it takes” to ensure growth stays in the 7%-8% range, with the upper half of the range preferred. We believe growth bottomed in Q1, with a relatively robust rebound in store in H2, marking a key economic turning point after three years of slowdown.

The People’s Bank of China (PBoC) cuts reserve ratios for small and rural banks, adding monetary stimulus to the fiscal stimulus already announced earlier this year. While in of themselves the cuts are unlikely to be highly stimulative, they signal the government is serious about improving credit conditions for certain segments of the economy, including rural areas and small enterprises. Remarks by PBOC officials indicate that targeted credit easing is now being encouraged.

Data releases over the past months indicate stimulus policies are starting to have an impact. Industrial production, retail sales, loan growth, fixed asset investment, exports and inflation have all picked up over the past two months, and we anticipate further gains in H2 2014.

Structural reform remains high on the policy agenda, but growth takes precedence. The clampdown on corruption and non-productive lending, the move to a true market-driven economy, improvement in environmental standards, and improved land rights for rural citizens remain key goals of the government. However, maintaining strong employment growth and social stability will take priority if there are short term conflicts between the two agendas – as there have been recently.

STIMULUS MARKS POLICY TURNING POINT
We expect China economic growth to pick up in the second half of the year, supported by loosening fiscal and monetary policy as well as improving external demand. China’s Premier has made it clear that he will do ”whatever it takes” (to paraphrase Mario Draghi) in order to maintain economic growth close to 7.5%, a level considered necessary to maintain full employment and social stability. In addition to the fiscal loosening announced earlier this year, monetary easing has now started earlier than most analysts expected.

Reserve requirement rate cut

The People’s Bank of China (PBoC) cut the reserve requirement ratio for small and rural banks by 50bps, effective June 16th. The announced cuts are in addition to the 50-200bps reserve ratio cuts for rural banks in April 2014. The cuts have been limited and carefully targeted, leaving plenty of dry-powder for deeper and broader cuts down the line. The cuts are also in line with the longer term moves to liberalise the banking system through gradual deposit interest rate liberalisation and bank consolidation.

Estimates of how much new liquidity the moves will inject vary from 95 billion Yuan to 50 billion Yuan. The change in the reserve ratio will apply to approximately two thirds of city commercial banks, 80% of non-county level rural commercial banks and 90% of non-county level rural cooperative banks.

Monetary and credit growth appears to be responding positvely to the cuts in the reserve ratios for rural banks earlier this year.

Potential changes to the loan-to-deposit ratio

The Deputy Chairman of China’s banking regulator, Wang Zhaoxin, said on 6 June that the regulator is considering adjusting the calculation of loan-to-deposit ratios (LDR). Many banks have hit the 75% cap and therefore their capacity to lend is constrained. It is expected that over the medium term, China will move to a liquidity-at-risk framework, eliminating the LDR requirement. But that would require a change in the Commercial Bank Law. For now, it is likely the changes will entail excluding certain types of loans from the calculation to allow banks to lend more freely, especially to small-to-medium sized companies.

Two-way currency risk maintained

The PBoC allowed the renminbi appreciate by 0.6% in the first half of June, defying those who thought the country had switched to currency depreciation strategy. The authorities have been at pains to introduce two-way currency risk to encourage better market discipline and prepare the country for further financial and currency market liberalisation. In our view, with the balance of payments still in regular surplus, reserves continuing to accumulate and the government actively encouraging a shifting emphasis from external to domestic-led growth and a continued move up the value-added chain, the renminbi will maintain a medium-term appreciation trend.

Local government financing reform being eased in

Following abuses in the early 90’s, local governments have been largely excluded from issuing bonds, with bank loans the main source of financing. However, reform is now being introduced, with the government stepping up its efforts to develop the municipal bond markets (with encouragement from the IMF) in order to increase transparency and reduce the growing reliance on hard to measure and control “shadow-banking” financing vehicles.

While the full development of a municipal bond market is some way off, the Ministry of Finance has been issuing bonds on behalf of local governments and some local governments are able to issue bonds within a quota. A total of 10 local governments can issue bonds with Beijing, Jiangxi, Ningxia and Qingdao being added to the list last month. The Ministry of Finance last week introduced the requirement that local governments must obtain credit ratings to issue bonds in a bid to bolster credit risk management. Last week the Ministry auctioned 51.6bn Yuan (US$8.3bn) worth of 3 and 5 year local government bonds.

Local government’s role in achieving targets reaffirmed

Premier Li Keqiang pressed local leaders last month to help the economy achieve its annual growth target. Li reminded local leaders of their “inescapable responsibility” to achieve this year’s economic targets and stressed that “no delay in action is allowed”.

Real economy responding to fiscal stimulus

Last month the State Council announced it will boost public investment in railway, highway, waterways, and aviation-network construction in the Yangtze River basin and cut some utility companies’ taxes by a total of about 24bn Yuan (US$3.9bn) a year. That will be positive for growth this year.

The real economy is already beginning to respond to the stimulus put in place earlier this year with industrial production, retail sales, loan growth, fixed asset investment, exports and inflation all rising and coming in higher than consensus expectations this month.

Investor sentiment is starting to improve

Recent actions and statements by key government officials and policy-makers make it clear that China will continue to pursue its reform agenda – at a more moderate pace if necessary – while loosening fiscal and monetary policy in order to reverse the three year economic slowdown. With economic data becoming more consistently positive and the government’s easing stance becoming more transparent, the China’s local A share market has started to trend higher. As one of the world’s cheapest equity markets, we believe that if the current policy stance continues and growth rebounds in H2, China domestic equity markets are in a position to outperform.

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For more information contact:
ETF Securities Research team
ETF Securities (UK) Limited
T +44 (0) 207 448 4336
E  info@etfsecurities.com

Important Information

This communication has been provided by ETF Securities (UK) Limited (”ETFS UK”) which is authorised and regulated by the United Kingdom Financial Conduct Authority (the ”FCA”).

When being made within Switzerland, this communication is for the exclusive use by ”Qualified Investors” (within the meaning of Article 10 of Section 3 of the Swiss Collective Investment Schemes Act (”CISA”)) and its circulation among the public is prohibited.
The information contained in this communication is for your general information only and is neither an offer for sale nor a solicitation of an offer to buy securities. This communication should not be used as the basis for any investment decision. Historical performance is not an indication of future performance and any investments may go down in value.

This document is not, and under no circumstances is to be construed as, an advertisement or any other step in furtherance of a public offering of shares or securities in the United States or any province or territory thereof. Neither this document nor any copy hereof should be taken, transmitted or distributed (directly or indirectly) into the United States.

This communication may contain independent market commentary prepared by ETFS UK based on publicly available information. Although ETFS UK endeavours to ensure the accuracy of the content in this communication, ETFS UK does not warrant or guarantee its accuracy or correctness. Any third party data providers used to source the information in this communication make no warranties or representation of any kind relating to such data. Where ETFS UK has expressed its own opinions related to product or market activity, these views may change. Neither ETFS UK, nor any affiliate, nor any of their respective, officers, directors, partners, or employees accepts any liability whatsoever for any direct or consequential loss arising from any use of this publication or its contents.

ETFS UK is required by the FCA to clarify that it is not acting for you in any way in relation to the investment or investment activity to which this communication relates. In particular, ETFS UK will not provide any investment services to you and or advise you on the merits of, or make any recommendation to you in relation to, the terms of any transaction.  No representative of ETFS UK is authorised to behave in any way which would lead you to believe otherwise. ETFS UK is not, therefore, responsible for providing you with the protections afforded to its clients and you should seek your own independent legal, investment and tax or other advice as you see fit.