China should be able to weather housing market correction but the worst scenario could see GDP fall below 5%

15th May 2014

A severe correction in the Chinese housing market could reduce China’s GDP growth to below 5% in the worst case scenario but central government intervention should keep the figure above 7% says Axa Investment Managers.

In a note from Aidan Yao, emerging Asia economist, the firm points out that the property market in China is slowing rapidly with falling house sales, easing house prices, and a decline in construction activity. The slowdown is due to lots of housing stock in lower-tier cities, tight monetary conditions for developers and home buyers and the government’s anti-corruption policy including a crack down on shadow banking.

The note says that the authorities can cushion the impact of the housing market correction by increasing fiscal spending, removing housing controls, and easing monetary policy. The Government is already expanding the construction of social housing which could also mitigate the impact of less demand for construction elsewhere.

The report says: “With its rapid growth in recent years, the housing market has become a critical part of the Chinese economy. Real estate investment accounts for about a quarter of total fixed asset investment, and it is related closely to many other industrial sectors, such as steel, cement, glass, and construction machineries, which provide inputs to property construction. In addition, companies use land and properties as collateral for bank and non-bank lending. As for the official sector, land sales are an important source of income for local governments, accounting for 36% of their 2013 revenue. Taking in account all these factors, market estimates suggest that a 10 percentage point decline in real estate investment could lower GDP growth by between 1.6% and more than 3%.”

However the research suggests that as a base case, growth in real estate investment will drop by about 4 percentage points, from 19.3% last year to 15.4%, and the lowest point since the global financial crisis. It continues: “Our estimate suggests that GDP growth will be lowered by 0.8 percentage points, falling from 7.7% in 2013 to 6.9%, all else being equal. In reality, however, all other things are not equal. As mentioned above, the government has already announced an increase in social housing construction, which by our estimate will grow by 6% this year. Given that social housing now accounts for about 20% of total real estate construction, the proposed increase will add 0.2% to GDP, taking it to 7.1%. As a reminder, we lowered our 2014 GDP forecast to 7.2% a few weeks ago.”

In the worst scenario, the research says: “As a tail-risk scenario, we assume construction activity slumps to a level similar to that in 2009, where the sector essentially stalled for half a year. In such a scenario, real estate construction will fall by 14.4ppt, to 4.9%. Applying our sensitivity estimate, GDP growth will drop by 3ppt, to 4.7%.

“We consider a market correction of this magnitude to be highly unlikely this year, as the government still has ample policy levers to pull and conditions have not deteriorated to such an extent that a systemic collapse is inevitable. We think a combination of appropriate monetary easing and more aggressive fiscal spending can help to contain the severity of the housing market correction.”

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