China's New Economic Normal Backs O’Neill’s Optimism

At college, I have been dedicated to studying Jim’O’Neill’s vision of BRIC economies. The seeming under-performance of these four emerging markets now seem to pale into insignificance compared to U.S. economic recovery and the ambitious Abenomics. However, Jim’O’Neill staysbullish on China in the year 2015. His article listed three reasons to be optimistic about China: the collapse of oil price will boost the purchasing power of the Chinese, deflationary pressure renders monetary expansion expectable, the presumed fall in real estate price is unlikely to cause credit crunch and will instead stimulate the sales of housing. While Monsieur O’Neill’s confident depiction of China in 2015 is overall realistic, I’d like to offer my alternative point of view on China’s prospect under the "new normal".

Shanghai's Bund Bull
Source: Google
China’s December CPI and PMI have both hit new low, indicating increasing risks of deflation. Stimulating measures such as cut in interest rate and reserve ratio are thus expectable in the first quarter of 2015. However, the long-term strategy of Renminbi internationalization requires PBoC’s discretion to stabilize domestic capital market and exchange rate. Thus targeted easing policies, whose importance has been re-emphasized in PBoC’s annual report, are more foreseeable. In addition, fiscal stimulus will play a larger role to push the economy closer to the target. Approximately 7 trillion infrastructure investment are initiated to begin construction in 2015. This fiscal expansion in general serves to rebalance the economy by modernizing the vast rural areas in less developed provinces and renovating obsolete urban public facilities. It also corresponds better to China’s proposed new normal economics, which suggests better public welfare, more environmental-friendliness, and a healthier economic structure that emphasizes fairness and equality. Therefore, China’s growth in 2015 lies more on the fiscal side. The monetary authority will implement some expansionary measures, but the magnitude could hardly resemble a quantitative easing equivalent.

On the other hand, one should no longer view China’s real estate market an integrated subject matter from 2015 on. For extra large cities, Beijing, Shanghai, Guangzhou and Shenzhen, year-end statistics of 2014 reveal an average of 10% growth in housing price, while the growth rate has shrunk a little compared to 2013. Major cities, such as Tianjin and Nanjing, witnessed moderate or zero growth in property price. The rest of Chinese cities experienced different degrees of recession in the housing market. However, Monsieur O’Neill’s idea that lower housing price increases sales is unlikely in the last two scenarios, where real income growth stumbled as a result of diminishing household wealth and bank’s growing reluctance to approve mortgage loans. The actual rationale behind the role of real estate in China’s economy involves government revenue through land auction, which is the greatest part of fiscal income for all local governments. Rising housing price funds fiscal spending, backs up banking leverage, and supports the growth in related industries and service sectors. By looking at the successful land bids in 2012, whose floor price in Beijing’s case is at least 5% higher than current price, one can infer the interval of housing price growth in 2015 with confidence, because estate projects built on these bids will be available for sale next year. The expectation of growing estate price boost household confidence, dispels loan provider’s circumspection, and increase business opportunities in construction-and-home-related industries, thus improves the economy as a whole.

Guanlan Jiayuan, Beijing's most upscale estate to be sold in the second quarter of 2015, is now under construction. The most expensive apartment is estimated to be worth ¥70 million, and average price per square meter amounts to ¥165,000.
Source: Baidu

Due to asymmetric information in the stock market and the lack of social-wide pension system, housing is the most secured and inflation-proof type of investment for ordinary Chinese families. China’s real estate price has been increasing at an incredibly high rate for the past ten years, corresponding to China’s GDP growth and Chinese people’s income growth. However, as China now allows for a lower growth target, housing price, along with related financial assets, will continue to step higher but at a moderate and sustainable pace. The same description can be applied to China’s new normal economics as well. With fiscal stimulus underway at the same time, there is enough reason to be bullish on China and its contribution to the global economy.

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