Property Barometer - "China Property Bubble" Why should we care?

“It has long been said that “when the United States sneezes the rest of the world catches cold”. China, is not quite the US yet, but these days as the world’s 2nd largest economy it is in the league of countries with “very significant global influence”. In addition, China has become South Africa’s major trading partner.”

“Therefore, at the present time, I would contend that when considering potential risks to the South African economy and its residential market, a potential Chinese “hard landing” appears to be the most obvious one.”

While Greece is currently big news, the real news and the real source of concern for the South African Property Sector is in part about property itself, and the possible bursting of a property and economic “bubble” far away from Greece

In my interaction with certain local property industry people this week, I couldn’t help but notice how many questions they had about Greece.

Indeed, last week’s Greek referendum, and big doubts about its future in the Eurozone, appear to have hogged the news headlines in recent days. However, while I have limited knowledge of the country, in my opinion the scary news for South Africa and its property market should really be China, and the state of the property market in that country is very much a part of this.

It has long been said that “when the United States sneezes the rest of the world catches cold”. China, is not quite the US yet, but these days as the world’s 2nd largest economy it is in the league of countries with “very significant global influence”. In addition, China has become South Africa’s major trading partner.

Therefore, at the present time, I would contend that when considering potential risks to the South African economy andits residential market, a potential Chinese “hard landing” appears to be the most obvious one. Where does residential property come into the picture? There isn’t an obvious strong “direct” link between the Chinese and South African property markets. Foreign buyers of South African residential property are a relatively small group, and the Chinese contingent of this group is believed to be far smaller than that. So, whereas it is rumored that Chinese property investors are a very significant group in certain developed world residential markets, and their pain felt at home could lead to a cutback in their demand in those markets abroad, we doubt there would be any noticeable “direct” impact in South Africa.

The potential impact of a “bursting bubble” in the Chinese property market, along certain other sectors it would seem, is more an “indirect” one via the impact on its economy, and on ours. There are some big estimates of supply overhangs in the Chinese residential market, and by this is meant millions of homes standing empty. Estimates of the size of the Chinese property industry GDP (Gross Domestic Product) are in the region of 15% of its total national GDP due to a large property development sector, and its contribution to overall Gross Fixed Investment has been estimated at not far shy of 30%. And, of course, various sectors supplying the development sector with equipment and materials makes its area of influence even larger.

A large oversupply of residential homes in certain regions, causing a major residential market correction, could therefore conceivably dent overall Chinese economic growth as residential fixed investment is driven lower. It isn’t only about the residential sector though, as reports of overinvestment in areas of the manufacturing sector and a surplus production capacity also emerge from that country.

A Chinese economic growth slowdown has a few potential implications for South Africa. On the “positive side” the fuelguzzling nature of modern economies implies downward pressure on global energy prices, and this can be very positive for domestic consumer price inflation. Indeed, as at January 2015 the IMF’s Energy Commodity Price Index had dropped by a massive -48.8%, not just about China but also about an increase in global energy supply potential in recent years. The point is that, while we saw a big impact in terms of a drop in our own CPI inflation rate early in 2015, we didn’t see any meaningful boost to economic growth emanating from lower oil/energy prices. This was in part because a global economy “off the boil” implies a drop in non-energy commodity prices, too, and in January the IMF’s Non-Fuel Primary Commodity Price Index had also declined to the tune of -11.7%.

This is what one could probably expect more of in the event of a Chinese Hard Landing scenario, i.e low energy and a host of other commodity prices, as it slows global demand for these. On the one hand, that dampens South African consumer price inflation, but on the other hand has a negative impact on South African value and volume of exports, and thus on its overall GDP, employment and Household Disposable Income. Slower disposable income growth obviously implies slower growth in residential purchasing power.

The potential impact goes further, however. It is difficult to see a Chinese “Hard Landing” scenario not being “Rand-negative”. Weaker SA exports implies a possible wider trade and current account deficit, while such a China scenario could also imply heightened investor caution surrounding emerging markets, of which South Africa is one.

A weaker-than-expected Rand obviously means upward pressure on consumer inflation and thus on interest rates. This could in part negate the downward pressure on inflation exerted from suppressed global commodity prices.

A further risk then emanates from SA’s currently high social tensions. Further downward pressure on already-anaemic economic growth and job creation levels can exacerbate the situation. This in turn can lead to heightened disruptions in the form of more aggressive industrial action and local government service delivery protests. This can disrupt the economy still further, and can be a further Rand-negative where it dents investor confidence.

The “China Hard Landing Scenario” does not appear likely to be a 2008-style shock, which involved a big CPI inflation surge due to the combination of a global oil price shock, a global food price inflation shock, and significant Rand weakness. This time around, the risk of such a big inflation shock to where our CPI inflation peaked in double-digits, appears a little less, due to oil price shock risk having been lowered by big investment in supply capacity in recent years. That would imply perhaps less risk of interest rate hiking of the magnitude of 2006-2008, barring a massive Rand weakening.

More likely, the China hard Landing scenario poses significant downside risks to SA economic, employment and disposable income growth, impacting negatively on residential demand in this way rather than through a big rise in the cost of credit. Nevertheless, the potential impact is negative, and the magnitude depends on how hard the landing may be.

In short, back around 2006/7 we occasionally flagged an oil price shock as a potential risk to the domestic residential market, due to a lack of reserve production capacity in the energy sector at that time. Nowadays, it appears that it is the possible bursting of a Chinese property bubble, along with weakness in other areas of its economy, too, that has significant potential implications for South Africa’s residential market.

The potential impact is not seen to be a direct one via any major withdrawal of Chinese investment in the SA residential market as a result, but rather an “indirect” impact via its impact on China’s economy, and therefore on our own, and thus on our household sector’s finances.

South Africa’s Household Sector has reduced its vulnerability to shocks somewhat, though lowering its Debt-to-Disposable Income Ratio from 88.8% in early-2008 to a most recent 78.4%

But that remains a high level of indebtedness by our own historic standards, and we are already an economy of weak GDP and income growth. Global economic growth is already slower than its mini-peak around 2011. We can ill-afford any further negative influences

It seems to me, therefore, that what happens in China’s housing market along with other troubled area of its economy is the big news to South Africa’s economy and thus its own residential market at present.

Source: John Loos (FNB)

 

Courtesy: The EAAB - Estate Agency Affairs Board

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