French multinational Saint-Gobain shut all its seven home decoration stores in Shanghai last year, an inevitable fallout of the beleaguered residential property market. Government control over the property sector has so far prevented overheating and implosion, but it is getting increasingly tricky to regulate this unwieldy sector.
For all its adeptness, the regime should begin to end its control over every aspect of the property market, before such manipulation becomes self-defeating. While the state is not likely to loosen its rigorous property policies in the short term, it may be forced to give the market a bigger role in handling prices. Since the start of 2011, the government moved swiftly to cool property prices. It set limits on the number of homes a family could buy in some cities, raised minimum downpayments on houses and introduced disincentives to help cool the market. Property prices in more than two-thirds of China's major cities dropped further in January.
But policy-induced measures to discipline this complicated sector will not be enough. More mature mechanisms such as introducing property taxes in every city will help balance the market. A major concern, however, remains. An artificially induced larger-than-expected correction of the property market can rattle the Chinese economy badly. The controlling polices need to be phased out, once property prices fall to a reasonable level.
This forced slowdown of property transactions has put the central and local governments at loggerheads. The central government's plan to construct millions of affordable homes over the next few years may give birth to Frankenstein's monster. Beijing wants local governments to bear most of the 2 trillion yuan (Dh1.1 trillion) cost to construct millions of affordable homes this year. On the other hand, provincial authorities are losing big revenue as the Centre has forced them to stop selling land to raise funds. Revenue from land sales in 300 large cities fell 67 per cent year-on-year in January. Beijing's revenue from land sales is expected to drop by 30 per cent this year to 90 billion yuan, making it the worst year.
This growing tussle between central government's determination to exert control on the housing market and local government's fiscal plight will take its toll on the Chinese economy and also the financial markets. Local authorities, which often operate like semi-corporate entities, have been forced to take harsh measures. Many city governments have stopped giving subsidies to lower income home buyers. Tensions are rising between various cash-strapped local administrations and a central government determined to preserve social stability by keeping housing prices low. Local governments must find a way to plug the gap in their finances. Not only do they have to subsidise cheap houses for the poor, they have to service the debts incurred while implementing the 2008-09 stimulus plan. Getting property equations right is crucial for China, as property investment makes up about 13 per cent of economic output.