China's astronomical home prices have been steadily falling in a dozen cities for four consecutive months. Will the price cuts herald a crash in home prices? If so, can China's banks withstand the shock waves? And since many local governments rely on the property sector, how can they service their debt without resorting to land sales? Chen Baizhu, academic director of University of Southern California—Shanghai Jiao Tong University Global EMBA program in Shanghai, discussed these issues with Shanghai Daily reporter Ni Tao. Q: The Peterson Institute, a US think tank, recently released a research suggesting that even if home prices in China drop by 50 percent, commercial banks will withstand the impact. Do you agree? A: You have to go to the basic statistics. If you look at the major banks, some of the banks, the Big Five, and all those shareholder banks, like the Bank of Shanghai and the Bank of Beijing, they are pretty healthy. Their non-performing loans (NPL) are very low, even lower than all the major banks in the world. Based on the NPL statistics, Chinese banks are the healthiest in the world. But there are more localized banks at a lower level. These banks may have a problem. You are talking about housing prices. To give you an example, for the Bank of Shanghai, housing loans represent a rather small percentage of its loans. The majority of its loans are for businesses, small- and medium-sized businesses which tend to be rather resilient and are the growth engine. I don't know where the statistics come from, the 50 percent drop in home prices, I don't know what is the rationale behind the conclusion. Certainly the assumption that housing prices will drop 50 percent is itself debatable. But given the level of NPLs of Chinese banks, the falling housing price will have a smaller impact on the Big Five as well as shareholders. But for smaller banks, they will have an impact. There is a lot of talk about this so-called shadow banking in China. An estimate is that shadow banking loans, the so-called trust, are 7 trillion yuan (US$1.12 trillion). Not all the loans are bad, some of them will be bad. My view is that some of the shadow banks will go bankrupt and so be it. Wealthy people who engage in shadow banking need to learn the risk. From the government perspective, I think the government needs to isolate the problem of shadow banking, so we can carve out the problem, contain the risk within the limited scale, so that it won't affect other parts of the financial institutions. Shadow banking will then be a manageable crisis. Q: Will the authorities intervene to prevent a crash in home prices? A: I don't think the government, including the national government, would leave the market as it is. The macroeconomic policy and the monetary policy would adjust so that there will not be a big crash in the Chinese market. Recently, the People's Bank of China required that banks cannot refuse to give loans if it is a first-time buyer and if the buyer satisfies the criteria. That is a signal, and the government has already taken the signal into account. They think the situation in some places is quite serious, and they have already signaled their willingness to loosen monetary policy a little bit. From the local government perspective, they have an incentive to drive up land and property prices. And from the national government perspective, it will adjust monetary policy. It may even lower the reserve ratio, I don't know if it is going to happen, but it is a possibility. Q: The Shanghai Pilot Free Trade Zone is facing stiff competition from other localities, for instance, Guangdong, which is contemplating its own FTZ. Does that mean Shanghai has to accelerate FTZ reform? A: Competition is good. Now you have the Shanghai zone, and soon Guangdong and Tianjin may be added to the list. Ideally, the whole Shanghai is a free trade area. The problem is, the government policy-makers don't know how big the impact is. And Chinese like to do experiments, in part to see how things will play out, in part to gauge resistance from interest groups. Their interests are being challenged, and there will be income redistribution. Once you have this paradigm shift, you always have wealth redistribution between different interest groups. So of course there is a lot of resistance. My strong view is that the negative list is probably a result of the need to satisfy some interest groups. Certainly pressure is on Shanghai municipal government to step up, otherwise the Guangdong project, near Macau, will overtake it. Of course, there is a practicality problem, but the mentality is that you need to be bolder, to make a bigger step. Q: Is it possible for local governments to issue municipal bonds to relieve their debt burden? A: That is a huge opportunity for the debt market, the fixed income market. The US financial market is two thirds of debt, one third of equity. China is the opposite. This is not right, I think. It probably made sense in the past, because in the period of rapid growth, equity is more important. If you look at the startups, for example, most of them are equity-financed. Very few are debt-financed. But when the economy matures to a certain extent, the fixed income becomes dominant. China has been growing over the last 30 years. Its economy has reached the point where 10 percent growth is no longer sustainable. We have to be satisfied with 7 percent. So it means that China is probably relatively mature. I don't know if we can use the age metaphor. A decade ago China was like 17 or 18 years old. Now it is 30 or 40, mid-age. The US is 40 or 50. When you get older, you want stability. So fixed income is a natural option. By 2030, China's population of old people over 60 years old will be 300 million, which will be more than the entire population of the US. And old people don't like stocks, they like stability. They would prefer fixed income, and so I think the trend in China is moving toward the US model. Eventually the proportion of the equity market will come down, and the debt market will go up. A debt market without municipal bonds is not efficient. In China, in the future, the bond market needs to be deeper and thicker. In the next 20 or 30 years, I think this is the trend that has to go. The municipal bond market needs to be developed. That can solve some of the problems of municipal development, which is now too reliant on property finance. Related News
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