Moving unsold mountains: Is China’s property rescue plan a game changer?

China opted to divert credit away from the property market to focus on industrial upgrading. The intent was that gains in industrial production and manufacturing would offset property woes. However, this strategy faces multiple problems. The “new three” already suffer from excess capacity (see Exhibit 2), price declines, and backlashes from export destinations. For example, US President Biden launched targeted tariffs on $18bn of Chinese imports. If eurozone countries follow, the damage will be much bigger since the EU represents a larger share of China’s exports. Furthermore, these new tariffs and rising geopolitical tensions may trigger further supply chain relocations out of China.

At the same time, the defaults of Evergrande and Country Garden, along with the dire financial situation of Vanke, the strategically important top-tier property developer, have rattled policymakers. Other factors, including moderating infrastructure capex, a sharp slowdown in government bond issuance in the first quarter, and weak credit impulse, have made it imperative that China focus more on domestic demand and putting its house in order. It is against this backdrop that the new property stimulus package was conceived. It was a forceful announcement, signaling that stabilizing the property sector has become an urgent priority.

The package

China’s property market rescue package is focused more on risk management than engineering another property boom. It aims to achieve multiple goals, including boosting housing demand, reducing housing inventory, and supporting developers:

• Land buybacks: Local governments may buy back excess land from developers at “appropriate” prices. Land can be used for affordable rental housing. Funding may come from special bond issuances, but local governments may have a low incentive to buy land amid tight financial situations.
• Inventory reduction: Local governments may buy excess housing inventory from developers at “appropriate prices” through local state-owned enterprises. Properties are then converted to affordable rental housing. The size of the bank loan is up to RMB500bn with the People’s Bank of China (PBOC) relending facility set at RMB300bn at a rate of 1.75% for a maximum of 5 years.
• Funding for unfinished projects: Banks are encouraged to meet reasonable borrowing needs of white-listed property developer projects.
• Eased home loan requirements: The minimum down payment is lowered by another 5 percentage points to 15% for first homes and to 25% for second homes, a historical low. The minimum mortgage interest rate restriction is removed, although many cities were not subject to this restriction already. The interest rate on personal housing provident fund loans is reduced by 25 basis points.
   

Challenges and uncertainties

The package, while welcome, may not directly boost sales or investment. Housing inventory is at multi-year high. The success of the rescue plan depends on the scale, funding, and execution:

• Scale: According to Barclays research, to lower the average number of months of unsold stock to 18 months of sales, which is considered a normal inventory level, from the current 33 months, the government would need to purchase RMB14.6tn of housing inventory, assuming the annual sales of new homes of RMB11.7tn in 2023 (see Exhibit 3). Assuming a 50% discount, this estimate equates to a government purchase of RMB7.3tn (USD1tn). The planned RMB500bn funding looks too small, only about 3% of inventory.¹

• Pricing: The goal of purchasing housing inventory is to arrest the downward property price spiral. However, an “appropriate” purchase price is hard to determine to ensure fairness. There is a risk of wealth destruction for certain parties. If priced at a huge discount, the proposal may discourage developers to sell or households to trade in. Price declines may ripple through other properties, causing a contagion effect.
• Local government participation: Local governments, already facing financial difficulties and delevering, may hesitate to participate due to lower rental yields versus the funding costs. In addition, the program is non-binding. Since lenders and borrowers are liable for future risks and bad debt, risk aversion may restrict uptake. According to Rhodium research, a similar pilot purchase program launched in early 2023 with a quota of RMB100bn was met with very little interest, with only RMB2bn uptake.²
• Buyer confidence: Confidence is key, as the program’s success comes down to people’s willingness to buy houses. Apart from upgrades or life event needs, households mostly have lost interest in homebuying (see Exhibit 4). With so much excess supply, expectations for home price appreciation are declining, and homes may no longer be perceived as a store of value (see Exhibit 5).

• Moral hazard: Government intervention in property purchases raises concerns about moral hazard, corruption, rent seeking, and unfair competition.
• Effectiveness: Previous policy stimulus, which generally produced short-lived market head fakes, highlight the challenge of tackling long-term structural issues in the market.
   

Conclusion and investment implications

China’s lackluster pandemic recovery and ongoing property sector woes have put persistent pressures on Chinese assets and the currency:

• The yuan (CNY) still faces depreciation pressure versus the US dollar (USD), due to wide interest rate differentials, heightened geopolitical tension, and a potential delay of Federal Reserve rate cuts. To stave off capital outflow, which has picked up pace recently, and attract foreign direct investment, the PBOC has been pursuing steady CNY fixing to maintain a stable currency (see Exhibit 6). However, this practice is likely unsustainable against any sudden shocks. We believe the path of least resistance for CNY is measured and gradual depreciation relative to USD. In the event of USD weakening, CNY tends to underperform as other currencies rally.

• The rally in Chinese government bonds (CGB) may pause and consolidate in the short run as the market gives the rescue measures the benefit of the doubt. The PBOC is aiming to keep nominal interest rates low with potential rate cuts. We expect the increasing bond supply will be accompanied by a liquidity injection and potential PBOC purchases. Short on safe-haven assets, banks and insurance companies are buying CGB bonds, which still look attractive due to high real yield relative to peers (see Exhibit 7) and high foreign currency-hedged yield. In contrast to the “high for longer” story for US Treasury yields, CGB yields are likely to stay lower for longer given the structural deflationary pressure in China. We believe there is a better entry point if the 30-year CGB yield goes above 2.65%.

The rescue package is a step toward stabilizing China’s property market, but its success hinges on overcoming significant challenges and reviving households’ confidence for home purchases. However, the stimulus may fall short again due to the size of the supply problem. The scale, funding, and implementation of the inventory purchases are too small and unclear. Hence, the rescue package is not a game changer yet. Mountains of unsold housing supply need forceful and persevering policies. Policymakers need to go BIG to revive homebuyers’ confidence. Absent a more material intervention, the magnitude of the property inventory supply problem likely means China’s property sector will be a drag to growth for years to come.