The Development of Chinese Mortgage Market and Its Critical Issues for Future Development - Case Study Example

The development of China’s mortgage markets and its critical issues for future developments Name Professor Course Date Introduction In1986 the China construction bank issued the first residential mortgage loan. The next 12 years that followed, the mortgage market developed very slowly. In fact, the outstanding mortgage balance was only 22 billion Yuan by the end of 1997. The rapid development of China’s mortgage market began in 1998 after the state council of the People’s Republic of China enacted some laws. These laws were aimed at extending housing reforms and accelerate the housing construction. This laid down the foundation of the current China’s residential real estate market. Before these most of the Chinese urban dwellers lived under welfare housing system where the state provided low-quality accommodation at a low costs (Malpezzi, 2010). The 1997 communist party announcement that it intends to phase out the welfare system and liberalize the market to encouraging people to own a house, kick started the development China’s property market. The state provided a onetime subsidy and a mortgage incentive, which helped faster adoption of the phase out. The phase out ended in August 1999, all unit built after January 1999 were bought and not allocated. This move set the China’s mortgage markets in motion. Since then the mortgage lending rate in China has been expanding at an accelerating rates, becoming an important driver of the country’s economy. Furthermore, the establishment of mortgage financing and government stimulus package in implemented in 2008 to curb financial crises encouraged the growth (Rajwani & Kumar, 2015) Consequently, the volume of the mortgage loan issued has drastically grown over the last two decades. In 1999, China’s residential mortgage loans to individuals doubled the previous year to reach Yuan 126 Billion. As at 31st August 2002, the outstanding balance reached Yuan 763 billion, which was almost 34 times the balance in 1997. The mortgage market was the rason behind the booming of the Chinese residential housing sector development and sustained china’s economic growth. According to national bureau of statistic data, in 2011, 25% of the fixed asset investment was real estate investment. Further more real estate investment accounted for 16% of the country’s GDP. Besides, real estate direct contribution to the economy suggests that its overall significance is even greater (Plunkett, 2011). However, it is important to note that the drivers discussed above are due to the government response and growth of China’s credit market. Other sustainable drivers such as demographic trends, raising income, upgrade demands, and lack of alternatives investment opportunities have also supported the growth in this sector. One of the significant drivers of the rapid growth of the China’s mortgage market has been the rural urban migration. By 2011, urbanization ratios in China - a portion of population living in urban areas- were more than 50 % from 35% in 1997 (Ortiz, 2014). Demographic divided was another driver of rapid development of the china’s mortgage market. The population aged 15-65 years otherwise known as working age population rose from 66% to 77%, between 1995 and 2011. Moreover, the individual and household income per capita income has increased significantly since the liberalization of the housing markets. This can be evident by the nominal urban disposable income per capita which rose by a compound annual growth of 10.4 % from US $ 929, per year to US$ 3500, from 1999 to 2010. This has fueled the demand for housing in China (Feinberg, Kuehn, Mckernan, Wissoker, & Zhang, 2015). Furthermore, the increased in upgrade demand, increased the demand for. Prior to this, the urban dwellers lived in small houses, which were of poor quality. The increased desire to own larger homes was the engine behind the growth of the residential real estate markets (Deng & Fei, 2009). As a result the per capita living space has gradually increased since 1997. In addition, the an underdeveloped capital market, which is evident by a closed capital account, volatile stock markets, low stock markets returns, low bank deposits, and small bond markets, means there are few options of investments available. This has made many households in China to allocate a larger portion of their saving and investment activity to property markets.(Chehui, & Zhangxingyang, 2011). Bubble indicators The rapid development of the housing sector in China has made the price of homes to rise drastically. This raised the debate of whether such growth can sustainable. This has raised the question as to whether such increases are sustainable. The bubble indicators in china housing sector have pointed toward what is known as overheated markets. The price of housing units has consistently increased, the average yield in major is declining, and the number vacant houses are on the rise. Although such indicators should be closely monitored, it is important to note that different markets respond differently. This means that due to certain unique characteristics china market may respond differently from united state markets (Zhang & Liu, 2012). In most cases, a consistence increase in price of a housing unit over long period is the most referenced bubble indicator. Recently, prices in US rose by a CAGR of 13%. The resulted to financial crises, whose impact were felt all over the world. Similarly, data from national bureau of statistics (NBS) indicates that such increases have been recorded in china housing sector. Between 2001 and 2011, the prices rose by a CARG of around 16%. This made the analyst to speculate that the housing market in china has reached dangerous level (Ben-Shahar, Leung & Ong, 2008). Although some analysts argue that the figure from the NBS does not accurately capture price movements, citing reason such as the price transaction fails to account for the increase in quality of new units; there is a consensus that the houses in China have become unaffordable. The collapse of US housing sector revived the notion that overleveraging' on cheap credit is an indicator of housing bubbles. However, in China this has not been a larger concern. This is because; all homebuyers are required to pay a down payment of 30% to 60%. In addition, Chinese culture discourage debt aversion, thus most household heave been keen to pay their loan and in most cases, before schedule. Moreover, the cases of drawing down on the mortgage or refinancing the mortgage on increased value of home are minimal. Owning a house in China urban areas, such as Shanghais is beyond the most of the households. The conventional affordability ratio is 21.3 for Shanghai, 20.5 Chengdu, which is considered too high. In fact, comparing the rates with other developed markets such as United Kingdom, where in the past five years the affordability ratio has not exceeded six. Moreover, the rates of inequality in China are very high. The Chinese in the 40th income percentile earns 40-220% more income per annum. When the affordability ratios are calculated only to include this class, they appear to resemble international norms. This perhaps explains the reason why the property rates have remained buyout the government intervention (Knox & Mccarthy, 2012). Rental yield is the other benchmark that is used to assess the inflated housing prices. Rental yield measures the buyer’s approximate rates of return on investment. Where the rental yields is close or below costs of borrowing, indicates that the prices are inflated and/or investors want to profit primarily through capital appreciation of the capital value. In the main urban areas such as Beijing, the return yields are 2-3 % and declining. This is an indication of speculative investment which tends to push the price higher. In such cases the preference for purchasing is speculative rather than for end use. In addition to the price of the housing units and yields, the number of vacant units is also housing bubble indicator. Higher vacancy rates point toward greater investment speculation. In such case the purchases do not reflect increased in demand. A Large number of numbers of an empty home is evident in China’s cities, however, such data is hard to find. The estimated China vacancy rate in China is estimated to be in the range of 15% (Rhee & Shimomoto, 2009). The government intervention Although there is no clear property bubble in China, the prices of houses have become a significant social concern (Ortiz, 2014).This has prompted the government to intervene, with a series of regulations designed to calm the market. Some of the government intervention includes; 1. The down payments requirement for the first and second home mortgage, which was designed to reduce speculation purchases. In addition, the government had forbidden third home purchases. 2. Home purchases restrictions, which forbid the multiple purchases of a home by single household. The law was designed to reduce the potion of household or individual income allocated to property market and especially number of t on home purchases. 3. Setting the targets price for homes, this refers to the parameters, which the Authority would like the residential price to, grew, were set 4. Limiting the participants: In 2010 all the government cooperation whose core objective was not in property markets, were required to exit the markets once their development was complete 5. Property tax in the main cities such as Shanghai, which was designed to reduce speculative activity as well as alleviating the local government dependency on land sale as a source of revenue. These interventions by the government can be categorized into either shorter or long-term interventions. Their primary aim is to reduce the heat in the market and prevent future financial crises like those witnessed in US. The precise direction of Chinese mortgage market is still hard to determine precisely. However, in short-term the critical issue is whether the expected price decline will surpass the government targets. On the other hand, the long term issue, is whether the mortgage development driver are sustainable, and whether the large volume of new supply observed can be justified. Already worrying trends has been observed, there has been a drastic slowdown of the property market in China. According to Wu, Dong, & Wang, (2015), the slowdown in 2014 was sharper than expected. This has resulted to many commentators suggesting that this could be the turning point for the housing sector, which can trigger financial crises like that observed in United State in 2008. Keeping in mind that the property sector has become an important pillar of Chinese growth as well as an essential source of elevated prices of commodities, a collapse of Chinese property market would hurt other sector, as well as other economies that depend on China to buy their export (Tang, Wong & Liu, 2006). However, due to some unique feature of Chinese market such as cultural that discourage debt aversion, adhering to government intervention measures, and immature consumer credit market. Therefore, such fears are unfounded. While the short-term issues remain the focal point of the current debate, the long-term trends are also crucial. For instance the working age population in china will peak by 2015 and recede from that point forward. The will result in reduction of the new first homebuyers, thus the residential house demand will drop. Furthermore, the lack of other investment option – arguably the greatest real estate driver- is also likely to change due to expected financial liberalization such as stabilization of stock markets. However, other drivers of demand such as urbanization, and income are expected to continue growing. As Dowall, & Ellis, (2009) observed since the fundamental drivers of the market are expected to reduce, the value of the properties is unlikely to remain higher. Given the high number of sector depending on the real estate industry, this will put a strain on the China’s economy. Conclusion Despite the price of housing unit rising drastically, and house affordability reducing, it is still hard to prove a housing bubble in China. However, bubble indicators such as consistence rise in price, increase number of vacant houses or low average yield have pointed towards increasing overheated markets. This has made the government react with a series of policies aimed at cooling the markets. Indeed, the short-term government policies responding to increased price have succeeded in cooled the markets. However, these interventions have also triggered fears of price reduction exceeding the targeted prices. Never the less the Chinese market is unique thus these concerns are unfounded. The fundamental drivers of market are expected to reduce thus the value of the properties is unlikely to remain higher. Given the high number of sector depending on the real estate industry, this will put the strain on the economy. Works Cited Ben-Shahar, D., Leung, C. K. Y., & Ong, S. E. (2008). Mortgage markets worldwide. Chichester, Blackwell Pub Chehui, & Zhangxingyang, Z. (2011). The Development Mode of Chinese Property Insurance After Financial Crisis Period. Procedia Engineering. 15, 4978-4982 Deng, Y., & Fei, P. (2009). The Emerging Mortgage Markets in China. 1-33. Dowall, D., & Ellis, P. (2009). Urban Land and Housing Markets in the Punjab, Pakistan. Urban Studies. 46, 2277-2300. Feinberg, R. M., Kuehn, D., Mckernan, S.-M., Wissoker, D., & Zhang, S. (2015). 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