2019-03-31

Housing Bubble or Bust for Local Governments

A week ago I posted Housing Market Rescues Begin, Subsidies for Buyers, Lotteries Whip Up Speculative Fever. The thrust of the post was about land finance, as explained in this article:
Since 2012, the ratio of land use right transfer fees to local public budgets has remained above 0.4. In the past two years, as the land transfer fees have risen, the ratio to local general public budget income has also increased. 2017, 2018 The ratio rose to 0.57, 0.66, more than half of the local general public budget income.
I wrote:
Way back in 2012, the central government realized land finance was an issue. Around 2014, the government started talking seriously about the issue, along with replacement revenue. There was serious talk of launching a real estate tax. Municipal bond markets were pushed because cities had been relying on land sales, and financing borrowings with revenue from land sales. As debt levels increased, the cities became more and more reliant on a revenue stream that is at the mercy of the cyclical credit market.
In response to financial pressure, local governments have already begun loosening real estate policy. The local governments say the easing is rational. The central government says policy can differentiate based on local conditions. It also repeats the mantra that "houses are for living in, not for speculating on," but the reality is that local governments cannot afford a rational housing market in a nation with a falling population. The "war for talent" is already morphing into a war for population as cities cannibalize each others' under-50 population. Smaller cities need speculative activity to drive prices demand (prices and demand are positively correlated in speculative markets). Absent demand, they cannot invest for growth, absent growth the real estate market slows even more. The persistent deflationary pressure hitting rural areas all over the developed world has come to China.

How bad are local government finances? Caixin has an in-depth report on a couple of localities that includes some shocking aggregate figures for the country as a whole: Souring Debt in China’s ‘Lemon Capital’ Warns of Looming Local Fiscal Crisis
Many believe that Anyue and Yanjiang are only the tip of the iceberg, and that China’s other small local governments may be sitting on a ticking time bomb of unsustainable debt. At the end of February, local government outstanding debt on the books had reached 19.1 trillion yuan ($2.8 trillion), equal to more than a fifth of China’s gross domestic product last year, data from the Finance Ministry showed. The number could be much higher when off-the-books debt is added.
The debt level must be understood in the context of reliance on land finance. Local governments finance investment and GDP growth with land finance. It's not simply that they can't pay off debt, they also can't make investments needed to hit GDP targets.
Anyue and Yanjiang made their moves in response to deteriorating debt situations. In 2017, both of their annual interest payments on special-purpose government bonds as a percentage of expenditures of their government-managed funds exceeded 10%, a red line that triggers a fiscal restructuring under the 2016 policy.

Local governments’ special-purpose bonds, designated to fund public works projects including infrastructure, are generally repaid with returns from specific projects that receive the investment. Those projects are usually incorporated into local government-managed funds. The lion’s share of revenue for those local funds comes from land sales, with last year’s national average percentage at 91%, data from the Finance Ministry showed.
It's 2014 all over again, but with much higher debt levels and greater reliance on land finance. An optimist will say China can stimulate the real economy without creating more malinvestment, greater reliance on land finance and real estate. The realist will say, every round of stimulus has done just that. Barring a surprise policy move, it's once again housing bubble or bust for many local governments.

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