Thursday, July 2, 2009
Rise in Asset Prices: New Challenge for Asian Central Banks
July 01, 2009 By Chetan Ahya Singapore, Qing Wang & Sharon Lam Hong Kong Quick Rebound in Asset Prices Across the Region The aggressive global policy response to defend against the slowdown has begun to gain traction, as real economic data have shown a slight improvement almost synchronously around the world. These attempts to revive growth have also resulted in a significant rise in asset markets, particularly property prices. Property markets have seen a meaningful rebound from the bottom across the Asia ex-Japan (AXJ) region, particularly in the financial centers of Hong Kong, Singapore, Seoul, Shanghai, Bangkok and Mumbai. From what we can surmise, property prices have risen by 10-40% in various pockets in the region (unfortunately, most up-to-date official national and city level property indices are not available). Hong Kong and Singapore, which are linked more closely to global financial markets, have seen the sharpest rebound. Price indices in some areas are close to the peak levels seen prior to the emergence of the global credit turmoil. Transaction volumes for the property sector have also increased significantly. The most surprising trend can be seen in Singapore. Although Singapore is likely to suffer the worst recession in its history in 2009, property transactions are now close to their peak. During January-May 2009, total private residence transactions increased to 5,531 units (annualized run rate of ~13,247 units) versus the peak of 14,811 units in 2007. Many Reasons for the Quick Rise in Property Prices First, a sharp rebound in the stock market around the region appears to have increased the confidence of the locals. The MSCI Asia Ex-Japan Index (in USD terms) has risen by 71% from the trough following the global trend. Second, excess liquidity in the system is rising. Central banks have cut rates aggressively in response to the global credit crunch, and the recent increase in capital inflows and trade surplus has added to this excess liquidity trend, as central banks appear reluctant to allow local currency appreciation in view of the still-weak external outlook. As a result, foreign exchange reserves in AXJ excluding China increased to US$1,446 billion as of May 2009 and are now close to their peak level of US$1,491 billion in April 2008. China's foreign exchange reserves have also risen back to an all-time high of US$1,954 billion in March 2009 after declining to US$1,880 billion in October 2008. Banks have cut mortgage lending rates aggressively. Average short-term rates have declined to unusually low levels at 2% on account of the aggressive monetary policy response. M1 growth in the region accelerated to 14.9% in April 2009 from a 6.6% trough in November 2008. Third, most countries in the region are implementing a fiscal spending plan of 3-5% of GDP, which has supported growth and employment. Fourth, most countries in the region also initiated measures to boost property demand during 4Q08 (e.g., Hong Kong, China, India and Korea). These measures included lowering the down-payment for getting a mortgage loan or relaxing lending norms for property and mortgages. Central Banks Already Voicing Some Concern What has been the central banks' response so far? Some have started to relay their concerns on asset prices. Last week a member of the Bank of Korea (BoK) board indicated that funds may be moving into stock and property. The board member commented, "Rising property prices may cause market instability". Similarly, a few days back, BoK Governor Lee Seong-tae mentioned that the BoK "also has to pay attention to the possibility of rising international raw materials prices hurting (domestic) price stability or for a rapid increase in short-term liquidity causing instability in real estate and other asset prices". Indeed, the governor of Korea's financial supervisory service (FSS) has already advised banks to maintain restraint when growing home-backed lending. A Chinese banking sector regulator recently vowed to monitor closely banks' lending behavior with a view to preventing allocation of bank lending to stock market and property. India's central bank governor also, for the first time since the credit crunch unfolded last year, mentioned that the RBI would consider reversing its expansionary monetary policy, but he did not indicate any timing on such a reversal. End of Monetary Easing, but Rate Hikes Are Some Time Away To be sure, the national level of property prices in countries other than city states has not risen as sharply to justify the aggressive policy response. Any potential correction in the global risk markets could also reduce the pressure of asset price rises. However, considering the pace at which property prices have moved up in certain pockets of the region, it does raise the risk of broader national-level price rises. The challenge for the central banks arises from the fact that the export and IP growth trend remains below potential and has not yet recovered meaningfully. AXJ IP is estimated to have improved to 1.6% in April 2009 from the trough of -7.6% in January 2009. However, it remains below the prior trough that occurred in 2001. Similarly, while exports are declining at a slower rate, they remain weak. Selective Controls May Be More Likely as a Response The key question is, if property prices continue to rise in the near term across the region, what would be the likely policy response? We are currently expecting central banks to start raising policy rates in 1Q10 as the growth trend recovers further. Our global economics team expects G10 growth to follow a slow recovery path, starting in 2H09. In this environment, any concerns about asset prices in the next six months could be addressed by sector-specific measures, such as tightening lending standards for the property sector and/or other non-monetary policy measures. What Could Be the Specific Policy Response in the Region if Property Prices Were to Continue Rising? Next, we highlight what we believe might be the policy response from the government in various countries. China: Despite the recent rebound in property prices, there is not a nationwide property price bubble in China, in our view (see China Economics: Property Sector Recovery Is for Real, May 15, 2009). Moreover, the recent recovery initially in sales and more recently in prices is broadly in line with the policy objective, which is to make real estate investment a new growth engine to help offset weak industrial investment. To this end, a stable policy environment is critical. Looking ahead, we expect the authorities' current policy stance vis-à-vis the property sector to remain broadly unchanged. In fact, we view the policy change to revive the property sector since October 2008 as policy normalization, rather than discretionary, countercyclical policy easing. The monetary and fiscal policy stance will hinge on macro developments. We expect the central bank to maintain the current accommodative policy stance for the remainder of the year. We continue to expect further normalization in loan creation each month, but this should not be interpreted as policy tightening. We also expect the base lending and deposit rates to remain unchanged through end-2009. Meanwhile, we do not expect additional fiscal policy stimulus of any meaningful size for the remainder of the year. The authorities' current property sector policy approach features two tracks: 1) encouraging market-based commercial housing by removing unduly austere policy measures that artificially depress its development; and 2) addressing the housing issue for low-income households by developing the low-cost, low-rent, affordable housing program financed by public funds. This is an effective and sustainable policy approach, as a viable economic housing program is predicated on a buoyant commercial housing program, in our view. In view of the property sector's importance in supporting an economic recovery and sustainable growth, any concern that a policy shift might potentially hurt this sector is unwarranted, in our view. That said, the Chinese authorities might decide to reinforce existing rules regarding bank lending to property developers and home buyers, down-payment requirements, mortgage interest rate discount for the first mortgage, and so on in regions where the local property prices are deemed to have risen excessively fast. Any reinforcement by the authorities would be done with a view to preventing abuse of these rules and a local property price bubble from developing. India: In India, although property prices are yet to stabilize, anecdotal evidence suggests that property prices have started rising back from the bottom in many pockets after having corrected by 20-30%. The problem in India is not as much the rebound but the fact that property prices had run up by 100-300% across top cities over a period of four years before the credit turmoil unfolded. Hence, the RBI remains vigilant on asset prices. Although the RBI has not officially made any statement directly reflecting concerns about asset prices, the RBI governor recently mentioned the need to consider reversing the easy monetary policy without indicating any timeframe for such a move. In our view, if asset prices rise significantly, the RBI may initiate measures to tighten lending to the property sector and also to start sterilizing excess liquidity from the banking system. In this regard, its first step would be to start issuing monetary stabilization scheme (MSS) bonds, and the second step could be to hike the cash reserve ratio (CRR). However, given the underlying weak export and industrial production trends so far, we do not expect policy rate hikes before 1Q10. Hong Kong: Our Hong Kong economist, Denise Yam, believes that the government is unlikely to intervene on property prices. The government may make more land available on the application list for property developers to trigger auction, while the HKMA may reiterate the guidelines on property lending, i.e., 1) remind banks to be prudent with mortgage lending and reinforce the guideline of mortgage payments at no more than 50% of household income; and 2) reinforce the 70% LTV ratio. Korea: Korea's property markets are facing different issues inside and outside Seoul. Due to the limited supply of land within Seoul, the property market there is more demand-driven, which is a function of liquidity conditions and sentiment. Property prices in Seoul corrected quickly during the credit crunch in 4Q08, but anecdotal evidence from industry experts and news articles suggest that prices in Gangnam have already rebounded 20% from the trough (although the official data say 2%). According to the Ministry of Land, Transport and Marine Affairs, sales of luxury apartments doubled in January-April compared to a year ago. However, in the provincial areas outside Seoul, land is abundant and home supply has sky-rocketed in recent years, causing record-high inventory problems. In our view, a single monetary policy cannot be applied to the entire country because of the differences inside and outside Seoul. Indeed, we do not expect the BoK to raise interest rates any time soon simply because property prices in Seoul have rebounded from the trough. BoK officials have been making more comments recently on the need to closely monitor asset price development. Some regard these comments as hawkish, but we view these as inflation anchoring by setting the expectation that the central bank will not allow asset prices to swirl out of control. After all, Korea's liquidity condition is not excessive, with M1 at 34% of GDP, while the private sector debt burden remains high, and so we believe that the BoK cannot afford to tighten soon. In order to deal with the different regional problems, administrative policies targeted at specific areas will be more effective. With asset prices in Seoul showing signs of rebounding, we believe that property market deregulation in speculative zones (which are mostly in Seoul) will slow or take a break. The restrictions on loan-to-income and debt-to-income ratios could be kept intact for the time being. On the other hand, we expect the government to continue to introduce more incentive programs to attract purchases of provincial property or simply use more public funds to buy the unsold apartments there directly. Singapore: Our Singapore economist, Deyi Tan, believes that given government authorities' modus operandi in the past, intervention in such initial phases of improvement appears unlikely. Nonetheless, both price levels as well as the pace of change will remain key factors to watch. If asset prices rise further in a rapid manner in the near term, the authorities could resort to supply-side and/or demand-side measures. Compared with supply-side measures, demand-side ones tend to have more severe effects on sentiment. For example, measures like capital gains tax are most draconian relative to others such as lowering the loan-to-value ratio and increasing the minimum down-payment/cash down-payment component. Supply-side measures would include instruments such as reducing the number of land-sites on the reserve list or reducing the time period for project completion. Historically, the authorities have handled each property cycle in ways different from the past. In the 1998 cycle, the property market was kept in check using anti-speculation demand-side measures, which eventually pricked the real estate bubble. In the 2007-08 cycle, passive demand-side measures such as the removal of the existing deferred payment scheme were used but to a lesser extent compared to supply-side measures. In our view, if the government perceives a further rise in property prices as speculative, we suspect that the government may initiate demand-side measures to rein in the real estate market rather than supply-side ones. Taiwan: Liquidity is abundant in Taiwan, with M1B at 73% of GDP, and if not controlled carefully, it could easily fuel an asset bubble, in our view. Demand for property heightened this year when mortgage rates dropped below rental yields. The continual trend of repatriation of Taiwanese overseas capital back home is a further contributor to liquidity. On the supply side, the dramatic cutback in presale cases has also helped to support prices. Sentiment revival is also an evident factor supporting asset prices in Taiwan recently. Anecdotal evidence suggests that property prices have grown faster in 2Q09 as compared to 1Q09, which we attribute mostly to the sentiment revival on the back of significantly closer economic dialogue between Taiwan and Mainland China starting at end-April. Speculation on the deregulation of property purchase by Mainland Chinese investors is among the hot topics in bolstering property investment confidence in Taiwan. According to financial daily Commercial Times, transactions of luxury homes in Taipei jumped by almost 20%M in May. Unlike the BoK, the CBC in Taiwan has not been making frequent comments on asset prices. Even in its latest statement following the rate freeze decision at its 2Q monetary policy meeting, the CBC did not mention asset prices and also commented that overall price level in Taiwan will remain stable. We therefore believe that the CBC will keep an accommodative policy stance by keeping its policy rate unchanged at a historical low of 1.25% for the rest of this year. It is difficult for the CBC to justify a rate hike with a record-high jobless rate and negative CPI growth. Neither the government nor the media in Taiwan appears concerned about asset price growth; thus, we believe that the likelihood of anti-speculative measures is rather unlikely in the near term. After all, the opening up of the economy and stricter regulations are opposing policies that can confuse the public and hurt the administration's popularity. Nonetheless, we continue to see strong upside for Taiwan's asset prices due to liquidity and cross-strait business opportunities, and so - if asset prices maintain their current pace of growth - more administrative policies could be seen in 2010, such as a higher down-payment requirement for presale cases.