TCS Daily

Beijing and the Bubble

By Christopher Lingle - June 23, 2005 12:00 AM

China is in the grips of a rapidly expanding property bubble. Prices are up 12.5 percent in the first quarter compared with a year earlier. Shanghai's property market bubble is more severe. The increase was 19 percent in the first quarter, year-on-year after a 26 percent rise in average home prices sold last year and average price increases of about 90% since 2000.

In response, Beijing announced a number of policy initiatives to dampen rising prices of real estate. Among these are taxes on property sales. And land left unused for more than a year will be taxed and sites unused for more than two years could face revocation of their titles to restrain property hoarding.

For their part, authorities in Shanghai imposed a 5.5% capital-gains tax on apartments sold more than once within a year and have proposed increased taxes on residential maintenance fees. Meanwhile, banks are beginning to require down payments of up to 50% on selected mortgages.

Instead of a concerted effort to stem the basic cause of rising prices, targeting speculators in certain cities is misguided and will be fruitless. Indeed, the proposed policy moves reveal a fundamental misunderstanding about the nature and cause of speculative excesses. Part of the confusion is over symptoms and causes.

A careful consideration of the over-valuation of urban property in China reveals that Beijing's policies are the central cause. Among the policy mistakes are those that support export-led growth, especially the peg of the yuan against the dollar.

Some foreign investors have bought property in hopes of receiving capital gains from a revaluation of the yuan. Allowing the yuan to revalue would end the inflow of money to speculate on property prices.

Additionally, speculative purchases of property have contributed to pricing pressures on important commodities like steel and cement. These pressures are also raising the cost of keeping the yuan pegged to the dollar.

In all events, it is correct to view the property sector as a potential source of economic and political instability. China's experience with the market economy has extended private ownership of homes and apartments to a new and growing middle class. The political ramifications of a bursting property bubble that depletes the fortunes of middle-class Chinese could be immense.

At the same time, enterprises employing construction workers or producing construction materials, as well as home appliance makers will begin to shed jobs.

Sharp declines in property values could also push the weak banking system over the edge, taking what is left of the value of household savings with them. Perhaps anticipating this problem, banks have been allowed to increase mortgage interest rates along with requiring large down payments from some house buyers.

A deflated bubble would increase bad loans held by state-owned banks that began making mortgage loans in 1998 when citizens were granted the right to buy and sell homes. Although household borrowing accounts for about 15% of the $2.3 trillion in loans outstanding last year, more than half of total lending involves property as collateral.

With low interest rates enticing both property developers and home buyers, it is no surprise that a real estate bubble has emerged. Instead of demonizing speculators for increasing property prices, blame should be directed towards Beijing for allowing the economy to be flooded with credit and for its own higher spending.

Without the excessive liquidity and easy credit, rising prices in one sector of the economy must be offset by price declines in other sectors. This clearly has not happened in China.

In sum, asset price speculation that leads to bubbles arises from conditions created by policy choices of politicians or central bankers or both. China's export-led growth policy and its doomed dollar peg are the primary source of inflated property prices. The bust after this boom could have a devastating political effect since disaffected citizens cannot demand a change in regimes.

Christopher Lingle is Research Scholar at the Centre for Civil Society in New Delhi.



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