The average transaction price for land sales across the country fell 32 percent in April from a month earlier and has dropped 51 percent since the start of the year, according to government data published by Credit Suisse. In some cases, local government land auctions have failed as bids fell short of the minimum level required.
For local governments with stretched finances that rely on land sales for the bulk of their revenues, the tumble in land prices could spell disaster. Furthermore, their vulnerability underscores the extent to which China relies on property as a source both of growth and of revenue to finance its sparkling infrastructure.
Just over a decade ago, most Chinese lived in homes provided by their danwei, or work unit, and there was no housing market to speak of. However, after Beijing decided to privatize the housing stock, the market took off and local governments began selling land for residential developments that fetched higher and higher prices.
From nothing 10 years ago, the contribution of land sales to local government revenues has soared, and last year total land transfer revenue nearly doubled from 2009 to about Rmb3,000 billion ($464 billion), according to CEIC, the data provider. That amounts to more than 70 percent of total local government revenues, according to data from HSBC. This year, by contrast, analysts at HSBC expect the figure to be less than Rmb2,000 billion.
Following tax reforms in the 1990s, local governments receive only 46 percent of all tax receipts, with most going to Beijing. But at the same time, they account for 77 percent of public spending and their responsibilities are growing, according to research from the U.S.-based Lincoln Institute of Land Policy.
“Recent tax reform has reduced the local government revenue and forced them to rely on land sales, fees and off-budget revenue to finance spending,” says Joyce Yanyun Man, a director at the Lincoln Institute. “They prefer to auction land to the highest bidder to maximize revenue. The incentive to produce more revenue leads to excessive land conversion.”
The mutual dependence between local councils and developers also gives rise to suggestions of collusion and kickbacks, according to Andy Xie, an independent economist in Shanghai.
The consequences are clear, with only a small proportion of housing being affordable. At the same time farmers often receive inadequate compensation for land that is converted.
Now that land sales are being discouraged as a source of finance, Beijing may have to rework all public finances and come up with another formula for paying for infrastructure and the social safety net that the country so desperately needs. “Fiscal policy reform is the key to social and economic problems,” Ms Man adds.
But the transition will be tricky.
“Local officials are all complaining about the restrictions. If land sales stop completely, debt service may become a problem,” says Helen Qiao, chief China economist for Goldman Sachs in Beijing. “There is a lot of debate about who will get into trouble first.”
Most vulnerable are the smaller, poorer cities precisely because their economies are less diversified, leaving them few sources of money other than land sales.
Nobody expects a run of defaults. Beijing already extends financial assistance to the most cash-strapped local governments. In addition, the finance ministry is expected to help local governments raise more money through the bond market.
At the same time Beijing has ordered local governments to ensure at least 70 percent of all land sales are for subsidized housing, slum redevelopment and small and medium-sized flats.
This, in turn, has deterred some local governments from selling their best land and is, analysts argue, a contributing factor to the drop in the average land price this year.
“Beijing can’t keep it [the order on subsidized housing] going long,” predicts Goldman’s Ms Qiao. “The impact on revenues is too big.”
That seems to be the conclusion that many real estate developers have also come to.
Government data show that investment in residential real estate in April rose 41 percent from the same month a year earlier, despite a 10 per cent year-on-year decline in housing sales volume for that month.
“A lot of developers are betting the government will loosen the tightening restrictions on the sector in the second half of the year and so they’re going ahead with construction,” says Du Jinsong, an analyst at Credit Suisse who focuses on Chinese real estate.