Why Beijing is determined to maintain its hardline property policies, despite the economic pain

Given its size and central role in the country’s economy, China’s real estate sector is ‘too big to fail’ and poses wider risks in the event of a meltdown
The push to see housing as shelter rather than an investment is more in line with China’s long-term growth goals but will not be painless

Aidan Yao

Published: 4:30pm, 9 Mar 2022

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A sudden collapse of China’s housing market has added to a long list of struggles facing the economy since 2021. Many see these woes as self-inflicted, a result of Beijing’s draconian policies. They remain baffled by officials’ insistence on continuing the curbs despite severe stress reverberating across the economy and markets.

Given the colossal size of the real estate sector, Beijing is taking a major risk with systemic stability by continuing its punitive actions. Our estimates about the size of the real estate ecosystem indicate that it is, in fact, “too big to fail”.

Combining property construction and real estate services, the sector directly accounts for an estimated 16 per cent of GDP. Once the upstream (production of building materials) and downstream (sales of appliances and furniture) outputs are considered, the sector could amount to as much as a quarter of China’s economy.

This is before taking account of the contribution of land sales to local government revenues, which are spent on infrastructure projects. There is also the banking system’s exposure to real estate via lending to developers and mortgage borrowers, which accounts for about 30 per cent of banks’ loan books.

Meanwhile, close to 70 per cent of households’ wealth is tied up in real estate, which puts consumption at risk in the case of a sharp decline in home prices. A sudden meltdown of the property market could therefore have serious consequences for China’s stability.

The importance of the real estate sector raises a critical question. Why is Beijing so determined to pursue policies that have already inflicted tremendous pain on a systematically important part of the economy?

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If the intention was to merely cool an overheating market, those objectives have been achieved. Yet, despite some recent policy fine-tuning, the authorities have kept the most substantive containment measures in place, suggesting a different objective than in previous policy tightening cycles.

There seems to be a fundamental shift in Beijing’s attitude towards the housing market. Underscoring this is probably a recognition that the current market development – characterised as reckless and debt-fuelled – is increasingly incompatible with China’s evolving long-term development strategies.

Rapid property price rises have acted as an amplifier of wealth inequality in society, making it an impediment to China’s goal of “common prosperity”.

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In addition, housing construction and the production of building materials are among the largest emitters of greenhouse gas in China. Continuing the economy’s reliance on property-driven growth – despite evidence of overcapacity – conflicts with Beijing’s push for carbon neutrality.

As an investment, property is an unproductive asset that creates no output and employment after completion. If the same resources were used to build a factory, which could be put to productive use thereafter, the economy as a whole would benefit from higher productivity growth.

Finally, and perhaps most importantly, fundamental demand for housing has already peaked. China’s demographic and urbanisation profiles suggest that housing demand peaked in 2018 and is expected to slow consistently in the coming decades.

While China still has room to build many higher-quality homes to meet people’s need to upgrade, that growth is also expected to slow. The housing market therefore faces a sombre outlook from a demographic standpoint.

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Beijing’s generous housing market policies have in the past encouraged developers to overbuild and households to speculate in an asset class that creates mounting social issues. These policies have had to be adjusted to steer a course correction.

Returning property to its roots as a consumable good that provides shelter for the people is the key objective of President Xi Jinping’s “housing is for living, not for speculation” concept.

This reallocation of resources will not be painless, as can be seen in developments over the past 12 months. And the adjustment is likely to last several years as the economy seeks new growth engines to replace real estate.

But kicking the can down the road could prove more dangerous if it were to eventually lead to a bigger bubble bursting, as evidenced in the US subprime crisis and Japan’s lost decades. Beijing might have already passed the optimal time to address the housing imbalances. It now appears to be trying to minimise the risk of future regrets.

Aidan Yao is senior emerging Asia economist at AXA Investment Managers