Dan Wang's Analysis of the Third Plenum
Hang Seng Bank's Chief Economist on China's Real Estate Market and SOE Reform
Hello, my readers! In today's episode, I bring you a readout of the Third Plenum from Dan Wang, Chief Economist of Hang Seng Bank (China). Dan was an analyst at the Economist Intelligence Unit in Beijing. Her analysis is highly accurate and worth reading if you want to understand how the Third Plenum will influence state-owned enterprises in sectors such as electricity and railways. Additionally, she discusses how the Chinese government plans to address the troubled real estate market.
Wang Dan, Chief Economist of Hang Seng Bank (China)
The context was originally a panel discussion first published on the Chat Lounge. after being authorized by Wang herself; it's my honor to publish her portion of the transcript.
Host Xu Yawen:
So, what's your main takeaway from the resolution and this plenary?
Wang Dan:
Actually, what struck me first about this plenum is the policy consistency, because it was a highly anticipated event. It was delayed for several months, and the Chinese market has undergone major changes both in the Chinese mainland and in Hong Kong. So we're expecting, we were expecting more of the reform in the realm of the monetary policy, physical policy, which were both mentioned heavily in the announcement.
And when I look at the Plenum Communique, it also stands out that the opening up reform will be further deepened. And there were a lot of talks about how to strengthen the state-owned sector, especially in the strategic industries, how to pivot the role of the SOEs so they can better cater the real economy. And for the financial system, there are a lack of details on what's going to happen for commercial banks, but it's quite clear that they're going to go through more consolidations. Our risk containment will be the key in the years to come.
Host Xu Yawen:
Dan, since the economic reform was the main focus, as the Third Plenum set a clear goal that by 2035, China will build a high-standard socialist market economy in all respects. And that's the guarantee for Chinese modernization. So for our listeners who are not very familiar with this high-standard socialist market economy, could you help us elaborate more on that, the concept of it?
Wang Dan:
So first of all, it's the market economy. So the market will play the ultimate role in allocating resources. And now what we need to point out is that in the past few years, the role of the state-owned sector has been strengthened for good reason. Because during economic downturn, the private sector is not spending. So the government and SOEs step up, and that's just a natural consequence. But on top of that, there is also the socialist element.
In the Chinese context, there are a lot of talks about remembering your original mission. The original mission is to eliminate inequality. And in every endeavor that the central government is trying to do and the long-term economic agenda, common prosperity is always the guiding principle.
So when we look at this round of the Third Plenum announcement, it has a lot of talks about income inequality, and that's closely related with the tax reform and also the development in the green technology, the strengthening of the supply chains. Because in the past, China has been relying on the old model, on the investment-driven, the housing-driven model. And it's heavily affecting China's economic ability to redistribute income.
Because unless you're in the construction sector, you in a way, one way or another, speculating the housing market, otherwise the wealth doesn't accumulate fast. But now we have shifted the focus to the high-quality productive forces, so basically innovation. So in the long term, this is the ultimate way to improve China's productivity, to ultimately improve the income distribution, and that is the way to develop Chinese modernization in the long term.
So for outsiders that haven't been to China in the past few years, they probably have missed the new scene that many of the Chinese cities has gone through this upgrade process. So it's not just the bridges, the high-speed railways, it's also the city infrastructure and the pipes, the underground infrastructure, the facilities that's improving the daily lives. So those things happen, don't just overnight, they need to take time.
And that means a better fiscal support and also, of course, the participation from the private sector.
Host Xu Yawen:
The resolution says that China will advance the market-oriented reforms in monopoly sectors within industries such as energy and railways. I'm not sure about you, but it's my first time heard about the government-issued documents clearly point out that they want to deepen reforms on SOEs in these two sectors. So what's your take on that?”
Wang Dan:
I was a bit surprised, too, for those two sectors to be singled out. But from the industrial perspective, it is also not a big surprise because when you look at the railway sector, for example, very few railways in China actually make a profit. But when you think about the benefit they bring to the local population, to the regional economy, it's tremendous.
So there has been talk about maybe we need a different management and evaluation system for infrastructure investment like this and how those companies should operate and what other models they can follow to actually generate more profit. Some of those railways are run quite successfully. For example, the one between Shanghai and Beijing, because that's where most of the population are flowing.
That's where the business activities are concentrated. But also several railways in Guangdong province, they're also doing well. And that is a combination of the malls, the local property development along with the railways.And that model was directly copied from Hong Kong. So in the future, we cannot expect the Chinese population to grow as fast as before. And the migration flow is shifting more from between provinces to the local counties to the provincial capitals.
So the migration flow is becoming more regional as well. And that means when we think about the future for Chinese railways, they need major reform. And for the energy sector, interestingly, it's a different direction, because most energy sector is quite profitable.
Even in this economy, it's not just the green energy industries, but also the traditional energy industries. Think about it, the coal, the oil. The more we stress about a green transition, the more profitable actually the traditional energy sector would become, because they're a very important supporting facility for the new energy, like solar and wind, since they're running by intervals, they cannot run there at night.
The more solar power station you build, actually the more coal power station you need to set there in order to make sure that energy would flow nonstop. So the main reform direction in this sector is that it tends to become monopolistic very quickly, because there's a high entry cost. The fixed asset investment is quite high.
Usually only the state-owned sector can afford the initial fixed asset investment, that amount of value. And the local government were heavily involved in a lot of those investments. And as we can see it, many of the local governments are also running out of cash.
They need more tax, a broader tax base in order to support the future build up of the energy facilities or further infrastructure investment. Reform is definitely needed and it actually requires much higher participation from the private industries.
Host Xu Yawen:
You mentioned the railway sector. This is just out of my curiosity because you said it's basically copied from the Hong Kong model. Right, the successful ones. But based on my knowledge, not long ago, the price of the subway tickets has been raised in Hong Kong. So do you think that will be also be the case here in Chinese mainland?
Wang Dan:
That's a highly controversial topic because when we think about the fare, the subway ticket fare, it's actually quite low by any standard. If we compare Chinese ticket prices to other emerging markets, this is quite low. And given the quality and service quality that we're getting for this price, Chinese people actually benefit big time.
But for Hong Kong, their local income on average is about one third higher than Chinese cities. I'm not talking about Chinese whole citizens, but only those living in urban area. So they can afford higher ticket for the subway or daily transportations.
Chinese mainland, unfortunately, I think this might be a main direction. The public services have been quite cheap and heavily subsidized by local government. But given the fiscal difficulties, at least in the short term, I can see a tendency to raise most of those prices, not big time.
Host Xu Yawen:
Dan, so speaking of the measures, the resolution supports high-quality growth and ensure security. It explicitly pointed out that preventing and defusing risks in real estate, local government debt, as you just mentioned, and small and medium financial institutions will be covered. Given the current market situation, what are the most pressing measures China needs to take to strengthen its financial security?
Wang Dan:
Well, the number one pressing issue, in my opinion, is Chinese banks. So most Chinese banks are highly exposed to the housing sector. There are about 4,000 commercial banks in total. 90% of them are smaller regional banks, which have been lending to the regional developers in the past 30 years. So in the past three years, we have seen this sharp downturn in the housing market. And as a result, many of those banks actually face the lack of liquidity or even a high ratio of bad loans.
So that issue is more complicated because now the interest rate in China is relatively low. So those banks do need to pay relatively high rate for the deposits that households save in the bank. It's also at a historical high record.
So the banks have much higher costs than before. And simultaneously, they cannot find very good assets. So most of those smaller banks have concentrated their assets in Treasury bonds.
So they have been busily buying the government bonds. And it's not sustainable. So the government has been talking about a consolidation of a lot of those smaller banks.
And since two years ago, we have seen the efforts of building some of the larger regional banks, combining the 20 or 30 of the smaller, like agricultural regional banks or even small county banks into one book. So that way, there would be some counterbalance within this bank, this smaller regional bank system, so that it won't easily be run on. But this reform will take many years before we can actually say that the banking system is stable.
And for the housing market, right now, it is still in the downturn, although the acceleration of housing decline has slowed in June. I mean, that's a, it is a kind of situation that people are trying to avoid, because in the past two and a half years, actually, the housing prices in the largest 40 cities in China has declined by 10% to 30%, depending on where you live. And that is a very high level of drop.
nd for many of the Chinese households, this is hard to accept, because on average, 80% of household wealth is stored in housing. And the government is trying to restore the market confidence by coming up with all sorts of stimulus throughout the past two years. But so far, none of those measures really has turned around the market expectation, because no one in this economy will buy an overvalued asset.
And people are still expecting the housing prices to fall further, and so do we. Because based on the current housing market supply and demand, the supply still way exceeds demand. And the fertility rate is going down, and people are postponing their plan to buy new homes.
And our forecast right now is that by the end of 2025, we'll reach a new equilibrium, because by then, people have been waiting for long enough. It's been three years since people have been seriously thinking about buying a new home. So even if people are not getting married, not planning to have a lot of children, they're still getting married, they're still having babies. So at some point, the pent-up demand has to be released. So the housing market, we believe, within a year and a half, will have a more stabilized situation, but right now, it's not yet. So the government has been trying to inject more liquidity to regional banks, trying to resolve the bad loan issues, at least make that problem less acute in the short term.
Host Xu Yawen:
Well, it's interesting because we noticed that in the resolution, it also mentioned about a broader policy towards the housing market, and it says reforms will be made to the financing methods for real estate development and the pre-sale system of commercial housing. With this new policy coming out shortly, how would that affect the existing issues in the housing market?
Wang Dan:
Those new measures that are announced in the Third Plenum are a common practice in the developed countries, that the developers need to secure financing first before they start constructing the homes. But in China, it's usually the case that the developers will collect payment and money from potential home buyers first while they started construction. And if anything happens along the way, because usually it takes three years to finish a project, if housing prices somehow start to decline, then people get panic, there will be a liquidity issue for developers.
Sometimes those buildings don't get built, and then the home buyers would lose big time. And for Chinese government, they would really want to avoid the situation. And it's also at the core of the property sector difficulty, because originally the government would really want to lower the leveraging ratio of Chinese property developers.
And we are familiar with the three red lines for the developers and two red lines for the banks. So it's all about reducing the exposure to the property sector as a whole. So far, I have to say by many metrics, this reform is a success.
Host Xu Yawen:
So how will China's property market be reshipped? What are we expect to see the developments or the scenario of the housing market in the coming years?
Wang Dan:
There are two layers of this issue. One is about the way that a government would increase the supply of those affordable housing, because a big part of that will be from the repurpose of existing housing stock. Because when we look at the first tier cities in China, there is no problem of excess inventory.
Most of those housing were already sold. And what's really a problem may be the occupancy. Sometimes people bought those houses, but they don't live in them.
There might be occupancy problem, but they can be sold, since people ultimately still believe the economic prospect of the tier one cities. But once you get out of the biggest cities in China, in tier two, tier three, or even in counties, there are tremendous amount of housing stock that are finished, construction long time ago, but never sold. So we don't know the exact size of this part of the excess stock, but the different estimates would suggest it's pretty big.
So the local government are trying everything they can to repurpose those properties. Some of them were already turned into affordable housing, but the local government need more money to actually purchase those stock and turn them into the low cost rental housing or some of the affordable housing targeting certain income brackets. But another layer of the problem is also constructing because the average lifespan for Chinese building, especially Chinese homes, is about 25 to 30 years.
For China, the commercial housing reform happened around 1998. For most of the homes in the market, they're still in use, but you can see many of them are in this dilapidated state. So the Chinese developers are really good at building them, but not very good at maintaining them.
So they need more money actually to keep up the condition of those homes. And for the government, of course, now they can swoop in and buy some of those homes at very low cost and turn them into the low cost rental housing. But the maintenance will be a problem.
So probably I don't think that they have enough finances to build affordable housing directly. The main model I think they have to rely on is still to take over the existing stuff.
To purchase from the residents. Yeah, from either the household directly or from the developers.
Host Xu Yawen:
So how can China stick to its state policy to deepen this opening up in the future?
Wang Dan:
The opening up in the past basically meant China would export more to the rest of the world. Actually, it has taken many different forms, maybe more foreign investors, multinationals set up their headquarters or factories in China. But the ultimate destination still is foreign countries, either in Europe or in the US.
But now the opening up has a different meaning because it's not just China produce things and then sell it to the rest of the world, but also opening up its domestic market, trying to import more. As exemplified by the central government several times last year, Chinese domestic market is a highly valued market for global investors because of its size. It's easy to scale up.
And for any type of business, especially consumer business, one way or another, you will end up in China. So the next step for the high level opening up reform doesn't just mean that China will strengthen its supply chain and to be a better supplier for other countries, but also become a better destination for investors and for outsiders to work and live in China. And it's quite key.