China Economy's Biggest Problem: Residential Construction

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Continued from Part One.

The biggest driver to China’s economy, though, was construction, with the twin planks of state-sponsored infrastructure and private residential construction. The former is unlikely to be repeated, in spite of government announcements that projects are being brought forward into 2012 from further out; any impact is expected to be limited.

With residential construction, Beijing has a major problem. A large part of the clampdown on speculative development was due to property prices rising beyond the level at which anyone but the wealthiest could afford to buy them. Falling prices have partly remedied that problem away from the major coastal cities, as another article explains.

In China, economists see a house prices-to-income ratio of about 7 as reasonable, as was historically the case in fast-developing Asian economies. By comparison, the norm in rich countries is closer to 4. While the ratio peaked nationwide in 2009 at 8.1 and has since fallen to 7.4, it has remained stubbornly high in China’s leading cities — 12.4 in Shanghai, 11.6 in Beijing and 15.6 in Shenzhen.

“Affordability has been improving since the correction started last year. But it’s not been happening quickly enough. That is why the central government has insisted on maintaining its policies,” Wei Yao, economist with Société Générale, is quoted as saying in the aforementioned FT article. If he is right, then we may not see any significant slackening of bank controls to lenders in the short term.

Beijing has tinkered with lending limits, interest rates and reserve ratios, but the impact has been minimal. A much more significant factor is the ban on home owners purchasing a second property and buyers’ perception that prices have further to fall. If the price is likely to be lower next quarter, “why buy this quarter?” will be the view of many canny Chinese buyers — and who can blame them.

The economy is, for a number of reasons touched on above, therefore unlikely to turn around anytime in the next few months.

Predictions of a pickup in the second quarter have been shown to be over-optimistic and the third quarter could be even worse. We can expect further action by Beijing, but with a transition to a new premiership due in the fall, it may be the fourth quarter before any more radical action is taken, by which time GDP growth could have slowed further.

Without China’s powerhouse economy driving metals demand, buyers elsewhere may be able to look forward to softer prices this year and into next.

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