It is “necessary” to burst the Chinese housing bubble

It is a tough, bold decision. “Bursting the [housing] bubble is a necessary choice for the healthy development of the Chinese economy”, said the official China Securities Journal in its editorial on the April 20 edition. Too high house prices are a heavy burden on consumers and raise risks for the financial stability, the growth, “and even social stability”.

The government has chosen to use administrative tools to deflate prices: it decided to raise the minimum down payment for purchases of a second home to 50% from 40% and the minimum for purchases of first homes of over 90 square meters to 30% from 20%. In order to avoid excessive discounts from official rates, it imposed a floor for mortgage lending at 1.1 times the benchmark lending rate. At same time, wrote Glenn Maguire in a Société Générale research, the government “is also doubling the amount of land made available to developers this year and building up to five millions ‘economic houses’”, from one planned in the 2009 stimulus package.

China is trying to get two goals. The first one is to deflate prices: “As the demand for speculative purchases is curbed, China’s property market will face a short-termadjustment”, the newspaper warned. “We believe house prices could fall significantly, up to 20-30%, in 2010-2011”, wrote Wensheng Peng and Jian Chang in a research for Barclays Capital.

The second one is to increase both activity and house supply: “Construction – added Maguire – has very strong multiplier effects through the economy but particularly to employment”. Therefore, an investment on new buildings multiplies income and jobs, even in other economic sectors.

This is an interesting experiment and it will be worthwhile to monitor those housing sector developments. According to Maguire, “if we assume that nominal household incomes grow by a 15% a year, which we believe is entirely plausible, while nominal house prices remain flat, then the average house price to income ratio should fall from its current level of 14 towards the Asian average of 6 within five years”. Chinese consumption will therefore be able to grow more rapidly.