Deflating asset price bubbles is a risky business. In fact, it is so fraught with potential danger that Alan Greenspan, the widely-revered former chairman of the US Federal Reserve, decided he would not even try. Rather than tighten policy in a deliberate attempt to control America's late-1990s technology stock boom, he reckoned it would be safer to let the bubble burst under its own pressure. The Fed would then step in to clean up the mess afterwards. China's economic policy-makers want to appear to be made of sterner stuff. The interest rate increase announced last week by the People's Bank of China was aimed squarely at reining in runaway investment, especially in the mainland's galloping property market. Whether Friday's increase, which lifted the one-year lending rate just a quarter of a percentage point to 5.85 per cent, will be enough in itself to prevent an eventual hard landing is doubtful. But the Chinese authorities obviously intended to send a clear signal that they are in earnest about slowing investment. Despite a series of restrictive measures introduced over the past couple of years, China's investment in fixed assets, including properties, continues to expand at an uncomfortably rapid pace. In the first quarter of this year, nationwide fixed asset investment surged to 1.39 trillion yuan. That sum is equal to almost a third of China's gross domestic product for the quarter, and is up 28 per cent from the same period in 2005. Urban fixed asset investment grew at an even more feverish 30 per cent. Of course, not all that money went into property, but a sizeable portion certainly did. According to official data, 17 per cent of China's fixed asset investment was sunk into real estate projects last year. In the first quarter of this year, developers invested 280 billion yuan in new construction projects, up 20 per cent compared to the first three months of 2005. Much of that investment was funded by the country's banks. According to the central bank, at the end of last year bank lending to the real estate sector stood at more than 3 trillion yuan, or 15 per cent of all bank loans. In fact, that figure probably underestimates the true amount. Company executives commonly mislead their bankers about the real purpose of the loans they apply for. They then divert the money away from core businesses and into speculative property developments in the hope of making a fast buck. According to some estimates, the true amount of China's fixed asset investment ploughed into the property sector could be 40 per cent, more than twice the official sum. Whatever the actual number, it is clearly big enough to trouble the central bank. Just last week PBOC deputy governor Wu Xiaoling warned that, given banks' growing exposure to the real estate market, the financial health of the property sector is critically important to the health of China's overall financial system. The big fear is that if property investment continues to outstrip economic growth, then the returns earned by that investment must diminish. If that happens, borrowers will default, and the proportion of bad assets in the banking system will rise. There are some signs this is happening. Last week, state media reported that China has more than 1.3 billion square feet of unsold, unleased space sitting empty in newly completed buildings, up 24 per cent from 12 months earlier. That is the equivalent of 662 vacant blocks the size of Hong Kong's Two International Finance Centre. Although recent reports give different figures for the value of bad loans to the property sector, they agree the amount is rising. By raising lending rates and tightening credit now, the authorities are sending a clear signal that they want to slow the pace of real estate investment to a more sustainable rate. But they have set themselves a difficult task. At 5.85 per cent, the one year lending rate is now greater than the 5.4 per cent rate by which nationwide property prices rose over the year to the end of March. In a uniform market, that should be sufficient to slow down investment, but China is anything but uniform. Cooling price rises in hot speculative markets like Beijing will prove a far tougher proposition. The central bank could raise rates again. But the one thing Chinese officials are desperate to avoid doing is slamming too hard on the brakes. If they make investment too expensive or difficult, they risk setting off a downward spiral in property prices that could fatally weaken the very banks they are trying so hard to protect.
