More challenging inflation factors at play this time
If I were a mainland developer loaded with debt, my legs would be shaking given the economic figures announced this week.
The Consumer Price Index, the key gauge of inflation, rose 4.4 per cent in October from a year earlier. That defies many economists' expectation that inflation will slow as the autumn harvest comes onto the market.
If there was any doubt the mainland is being affected by inflation it has now been removed.
What's more important is the amount house prices contribute to inflation. While property prices played a very minor role in the 2007 inflation, the 4.9 per cent increase in mainland property prices last month accounted for 16.6 per cent of the October inflation.
The cooling of the property market is now no longer just a matter of bringing home the authority of state leaders who have pledged to bring house prices down but so far had little success.
It is now tied to the battle against inflation and therefore the political stability of the communist regime. A much longer and intensive cooling is what we are going to see.
To get a better idea of what is ahead, let us revisit what Beijing did the last time inflation pummelled the economy. Between February 2007 and July 2008, monthly inflation rose from 2.4 per cent to a peak of 8.9 per cent peak before calming down to 7.7 per cent. These were Beijing's responses:
First, within nine months, the central bank raised the lending rate six times to 7.29 per cent by December 2007. There was a rate increase about every 45 days on average.
Second, the ratio of commercial banks' reserve deposits with the central bank was raised 11 times, to 16 per cent in April 2008.
Third, in January 2008, loan quotas were imposed.
Fourth, price increases for petrol, natural gas, electricity, public transport, heating, as well as tuition fees were banned. And vendors had to seek approval before raising prices for grain, cooking oil, milk, meats and eggs.
Fifth, capital inflows were tightly controlled. Developers were barred from sending foreign exchange into the mainland. All housing deals had to be done in yuan.
The result was a piling up of fire-sale proposals on the desks of foreign real estate funds and the launching of loan restructuring among highly leveraged private developers. Even Wang Shi, the chairman of China Vanke, known for its prudent management, said in April 2008: 'We are preparing for the worst.'
Had Lehman Brothers not gone bust and forced Beijing into a 4 trillion yuan (HK$4.54 trillion) stimulus package, many of the developers would have long been crushed by their heavy debt. Will they be so lucky this time? Will there be another crisis of equal scale? It is hard to tell. But there are some telling differences between now and 2007.
During the 2007 inflation, Beijing was in debate, if not denial, until the last moment. When the CPI reached 5.6 per cent in July, government officials were still arguing among themselves whether the inflation was a real or seasonal one.
It was not until December 2007 that consensus was reached and draconian administrative measures, such as loan quotas and price controls, were imposed.
This time, consensus came at an early stage. Premier Wen Jiabao described combating inflation as his top challenge in an interview with CNN in early October.
In the past two weeks, many of the 2007 strategies have reappeared, including a rate increase and capital inflow controls.
However, in an economy where loans are not meant to be repaid, the effectiveness of a rate increase in taming inflation is questionable.
In 2007, the Shanghai A-share index reached its historical peak of 6,196 points on October 12. That was eight months after the first rate rise. (In that sense, the market rally this week following the inflation announcement is of no surprise.)
Inflation headed down 16 months after the rate rises but seven months after the introduction of loan quotas. So if history is any guide, more rate rises, loan quotas and price control are to come (in this chronological order).
It is fair to say that developers have seen these all before. But today we are talking about high gearing recently acquired to bet on a softening of Beijing's stance on the property market and a quick return to the good old days (see table).
Today we are talking about counter-inflationary measures of a magnitude and duration that have not been seen before. In 2007, the battle was against striking growth in ordinary lending. Today it is against a 4 trillion yuan economic stimulus, a global liquidity flood and a freshly announced US$600 billion quantitative easing by the US.