Property market 'too big to fail'?

Chinese consumers are accustomed to all types of government measures to restrain rising home prices. Now it's time for a probable turnaround.

Property deals in Hangzhou in East China's Zhejiang province are set to terminate if the actual transaction price is 15 percent lower than that developers recorded with the municipal government.

Hangzhou is the provincial capital and the first city in the country to set a "bottom line" for a new - home transaction price. But the city government later clarified that it was not setting a "bottom line" for home price drops; instead, it means to regulate the pricing behaviors of developers.

In April, the city had the country's biggest month-on-month price drop, 0.7 of a percentage point, according to the National Bureau of Statistics.

China's property sector is too big to fail. It's a key growth driver, contributing 16 percent of gross domestic product and 25 percent of fixed-asset investment. It has considerable spillover to more than 60 industries.

"Considering the importance of the property sector to China's economy, we think the government will introduce more loosening measures to mitigate the impact of a housing-market slowdown," said Stephen Green, economist with Standard Chartered Plc.

Several city governments have announced loosening measures, including relaxation of purchase restrictions, lower down payment requirements and easier access to local bank mortgages.

"We expect more lower-tier cities to follow suit, which will help prevent local markets from collapsing," said Green.

The central bank has also asked banks to speed up mortgage lending, set mortgage rates at reasonable levels and do more to meet first-home buyers' mortgage requirements.

"The change of relevant real estate policy is usually used as a shot of adrenaline for the overall economy. But will that always work?" said Mao Daqing, vice-president of China Vanke Co Ltd, the country's largest property developer by market value.

China's real estate market has been correcting since the beginning of 2014, with slumping sales and falling prices. Among 70 major cities, eight saw month-on-month price drops in the new-home market last month, doubling from March, according to the NBS.

"We expect this downshift of momentum in the residential property markets to persist along with a macroeconomic slowdown this year," said James Shepherd, head of research for Greater China at Cushman & Wakefield Ltd.

After dipping to 7.4 percent growth in the first quarter, China's economic expansion showed no signs of recovery in the following period as many had expected. It raised the risk that China may miss its economic growth target, of 7.5 percent, for the first time in 15 years.

Almost all the leading economic indicators, such as industrial output, fixed-asset investment and retail sales, showed signs of weakening in April.

Many economists said a persistent and sharper downturn in the property sector is the biggest risk for China's economy in the next couple of years.

"The ongoing correction in the property market is a key to watch for growth and policy response," Chang Jian, an economist with Barclays Plc, said. "The tightening of monetary financing conditions, combined with overbuilding and increased developer leverage in 2013, have worsened the housing market's supply-demand picture. And the current downturn will likely continue into 2015."

Self-fulfilling prophesies of falling house prices, developers' rising financial difficulties on the back of a highly leveraged economy with huge local government debt and a fragile financial system with a large shadow banking sector suggest risks of a disorderly adjustment are rising, Chang said.

"It is true that the property sector posed the biggest risk to China's economy in coming years," Wang Haifeng, a researcher with the Institute for International Economic Research at the National Development and Reform Commission, said. "The earlier the correction, the better. A slowdown of the economy is the cost we have to pay."

Quite a number of foreign investment banks lowered their forecasts for China's economic growth because of the real estate sector.

UBS AG lowered its 2014 and 2015 forecasts to 7.3 from 7.5 percent and to 6.8 from 7 percent, respectively.

"Our sensitivity analysis suggests that a 10 percentage point drop in the growth of construction volume would result in a 2.5 percentage point drop in GDP growth, including second round effects," Wang said.

Nomura Securities Co Ltd said declining real estate investment could drag economic growth to 6.7 percent for 2014 and 5.8 percent for 2015, if there are no policy stimuli.

"Our baseline remains that the government will have to loosen fiscal, monetary and property sector policies significantly to achieve our forecast for 7.4 percent GDP growth in 2014," Zhang Zhiwei, a Nomura economist, said.

This expectation may turn true. On May 22, Premier Li Keqiang visited Chifeng in Inner Mongolia autonomous region. He said the economy is generally stable but faces downside risks and the government should take it seriously.

"We believe this statement is stronger than his statements from previous speeches and indicates policy easing may pick up speed," Nomura's Zhang said.

"It reinforces our view that fiscal and monetary policies will be loosened in the second quarter to stabilize growth and counter the macro risks from the property market."

China's property downturn will also impact the rest of the world. Commodity exporters and some regional economies with large exposure to China's domestic demand would be most affected by a property downturn in China. Commodity prices and currencies may react negatively too, according to UBS.