It’s often said that ‘When China sneezes, Macau catches a cold’.
At a joint business chamber luncheon last month, members and guests were reminded of this old adage. Guest speaker Joe Zhou, regional director and Head of Research for Jones Lang LaSalle in China, presented his views on the influence of China on Macau’s real estate market.
He gave interesting insight on the dynamics and intricacies of the Chinese economy and how invariably it has impact on us here in Macau. Especially so when it comes to property which underpins much of the wealth and well being of the local community.
World economists and laypeople alike watch China’s GDP numbers closely to gauge the health or otherwise of the economy. Whether we can believe the numbers or not China’s 8% GDP appeared to remain constant from 2000 to the end of 2011. An enviable figure for many countries. Growth was stabilized thanks to massive stimulus; the economy was supported by ample liquidity and strong infrastructure spending.
Then a gentle decline began and at the end of 2015, China announced 5 objectives aimed at halting this slow-down. These tasks centered on supply-side reform; expanding fiscal spending, reducing property inventory, lowering corporate costs, de-leveraging and reducing over capacity. The concern is however that short term growth may come at a price and impose higher risk to the economy in the long run.
By lowering corporate costs through reduced taxes for example, the government has less to spend on social benefits and infrastructure. Credit expansion has been accelerated; banks have been encouraged to lend and local governments allowed to issue bonds to finance infrastructure spending. Reduction in property inventory released on the market together with rapid household wealth accumulation led to house prices surging over the past 10 years. To climb the housing ladder buyers increased their leverage. Over 50% of the bank loans went on house purchasing. Sales volumes went up six times across 20 of the main cities in China, and prices skyrocketed.
To rein in the price rises, in October last year a tightening policy was implemented resulting in a 30-50% drop in purchasing across the mainland. Inventories in most cities are at record lows. In the last 6 months developers have been finishing off major residential projects so inventories are starting to build up again but they are cautious about starting more for the time being. This will keep supply low, and prices up.
With such lavish spending on infrastructure to boost growth, China now faces a huge debt burden. In 2015, government, corporations, household and bank debt stood at a total of almost 250% of GDP, up from 160% in 2008, and Zhou anticipates this to grow to 300% in 2016. However the risk is that if the Central Government holds back credit, this will lead to a further slowdown in GDP.
Then there’s China’s dilemma over its currency policy; by intervening to keep exchange rate substantially below the level the market would set, currency prices are distorted which in turn adversely affects China’s own economy: it encourages large-scale investment in export manufacturing, and is discouraging to investment in the domestic consumer market.
Whilst in 2016, negative net exports further dragged GDP down, Zhou explained that exports are vital to keeping people in jobs. Employment drives domestic consumption which in turns drives growth. When people buy homes they need building materials to redecorate, then they buy furniture, electronics and the like which all contributes to consumer spending that cycles back into the economy.
China remains the world’s best consumption story on account of its rapidly growing middle class. But it’s the demographics that have analysts concerned. In the ten years between 2010 and 2020 it’s estimated that China’s urban population will move from savers to consumers to the point that there will be an almost 20% decline in the savers generation and an over 80% growth in the consumer generation.
Zhou used the analogy of his parents’ generation which would save $8 in any $10 earned. They used savings to buy a home, rather than taking a bank loan. Their children on the other hand belong to the consumer generation. They use their parents’ savings to put a deposit on a home and spend most of their earnings. Now their children are growing up, but with no more parental savings to rely on, where is the money going to come from for this young generation to buy their own home? Bank lending is the answer; higher leveraging is today more the norm than the exception and this comes with its own risks.
Zhou presented three possible scenarios being predicted for China over the coming couple of years. The global economic forecasters differ in their opinions; Capital Economics expects a gradual slow-down, Oxford Economics believes 2017 will be stable but 2018 will see a substantial slow-down. The EIU on the other hand has an aggressive forecast of a hard landing and China’s GDP dropping to 4% in 2018. Zhou prefers the EIU scenario, saying that for long term gain can be achieved after short term pain. For stability purposes however, he believes China will probably aim for no worse than a gradual slow-down.
What are the implications of all of this for us in Macau? The headwinds come in the form of economic volatility within China, policy uncertainty and interest rates likely to rise and borrowing will become less affordable. Up until recently China’s investors have been very active in the property field. In 2016, China exceeded the US for largest investor, globally. 38% of high net worth individual Chinese hold overseas investment. But policy changes that tightened capital controls have led to Chinese buyers coming unstuck in places like London where they put down 10% deposits on off plan properties and now they are defaulting as they cant get their money out of the country. There’s a high risk of this in Macau.
The tail winds however are that Macau has solid underlying fundamentals: unemployment is low and the local property market is still healthy. Real estate demand is driven by equity and not debt. Unlike the US where mortgage leveraging was sometimes in excess of 100%, amongst the Chinese it tends to be less exposure at 40-50%. The Hong Kong-Macau-Zhuhai bridge and other new transport links will further integrate Macau within the region.
Zhou ended on a sober note, warning that if China is heading for a hard landing, Macau’s tentative recovery is at risk. 2017 is expected to be relatively stable with residential properties holding their price, but we are at the mercy of the health of the economy across the border and could all be in for a big shock come 2018.
