China Needs More Inflation To Steady a Wobbly Property Sector 

In our 1H Macro Outlook, we highlighted property as a key downside risk for growth in 2024. While property sales were already slowing down at the end of 2023, the decline has been more significant than what we anticipated. Through the first quarter of 2024, property sales have dropped 28% nationwide. Without stabilizing property demand, it will be much tougher to get out of the deflation that China has been in since early 2023, which will weigh on the growth outlook.

After three years of a brutal adjustment, and a patchwork of measures aimed to steady the sector, the property market’s continued descent at this point has much more to do with macroeconomic conditions than the sector per se. Band-aid solutions, such as removing purchasing restrictions and injecting liquidity to support developers, have so far proven inadequate in addressing the sector’s woes.

To shore up the sector, China needs more demand. For instance, the broad economic slowdown has led to >3 percentage points decline in Chinese households’ nominal income growth (~70% of which can be attributed to lower inflation), while the mortgage rate has dropped by only 1.6 percentage points. That spread means that property prices should drop by roughly another ~20%.

Another source of demand that has been affected is investment demand, which accounts for ~20% of total property purchases. Investors will be discouraged to hold onto their property portfolios in this environment and more inclined to sell. If investment demand continues to deteriorate, that would contribute to perhaps another 10% drop in property prices.

All told, our estimate suggests that property prices would need to fall by ~30% from its recent peak in early 2021 to reach a new equilibrium before buyers enter the market again.

However, with a typical debt/asset ratio of >80%, property developers can’t afford 30% drop in prices because that would lead to insolvency for many developers. Corporate data suggest that developers that have defaulted usually cut sales price by ~15% by the time of their default, because more significant discounts mean that nothing will be left for the developer after repaying debt (see Figure 1).

Figure 1. Developers Rather Default Than Offer Aggressive Discounts
Note: This shows percentage of monthly sales price drop from peak (yuan/m²) right before these developers defaulted.
Source: Wind and MacroPolo.

So the mismatch between consumers’ expectation of further price declines and developers’ unwillingness to cut prices has created something of a stalemate. Policy intervention can help to make demand return faster than it would otherwise to stabilize the sector.

One option is to cut mortgage rates further. But that will likely be less effective because the mortgage rate is already at its lowest level in two decades. Instead, China likely needs more inflation through more aggressive stimulus to bolster property demand. Inflation will not only lower the real interest rate (interest rate minus inflation), it will also make the average Chinese household relatively richer so their willingness to purchase homes today, rather than waiting for prices to find the bottom, will also rise.

During past stimulus periods, inflation on average rebounded by more than 2 percentage points within a year (see Figure 2). Based on our quick estimate, a combination of 200 basis points rebound in inflation and 50 basis point mortgage rate cut could be sufficient to stabilize property demand.

Figure 2. Annual Inflation Rebound During Past Stimulus Periods
Source: Wind.

However, a broad-based stimulus still does not appear to be in the cards anytime soon, while the latest data reinforce more deflationary risk. On the supply side, the PPI has been negative, while industrial capacity utilization has dropped to 73.6% in the first quarter, its lowest since early 2020. On the demand side, CPI has fared marginally better, but consumption growth remains weak as March retail sales only increased 3% year-on-year.

Stubborn deflation in the macro environment will have significant knock-on effects on the property sector and continue to hurt demand. This suggests that a U-shaped growth is still the more likely scenario, in our view, with 2024 growth ending up closer to 4.5%. We will provide more updates in our 2H Macro Outlook.

Houze Song is a fellow at MacroPolo. You can find his work on the economy, local finance, and other topics here.