Tuesday, July 28, 2009

China: Hot Money Blowing Bubbles

Surging Hot Money Makes Big Bets on Property Bubble

100 Billion in Foreign Capital “Wheels Around and Strikes Back” in the Second Quarter

Wan Jing
China Securities Journal, July 29, 2009

Apologies for the long article. It is quite interesting look at the surge in “hot money” into China this year, and its effect on the real estate market. Worth the time it takes to read (and a look at the illustration through the link – sorry, can’t upload pictures).

Illustration (by Han Jingfeng): House, “Domestic Housing Market”, Man in house, “Quick, come in out for some shelter”, Traveler, “Overseas Funds” (See http://paper.cs.com.cn/page/17/2009-07/29/B02/20090729B02_pdf.pdf)

“Ever since the lifting of the ban ‘limiting outside commands’ in the Shenzhen housing market in April, there has been a proliferation of property transactions at various ports and the number of Hong Kongers buying property has increased by 20 to 30 percent,” the manager of Shenzhen Futian Port Intermediary told a China Securities Journal reporter. After the steep decline in property prices last year, beaten Hong Kong investors have staged a comeback; meanwhile several high-end housing developments in Beijing have also made sharp allegations that in the most recent period the ratio of foreign funds purchasing housing has risen sharply, of which there is no lack of wealthy Euro-American and middle Eastern investors; and in June, 306 units of luxurious housing were transacted in Shanghai with a price of over 40,000 yuan/square meter, exceeding the total transactions from May, and over 20 percent of the buyers were from overseas…

With the sharp recovery in the housing and stock markets, the hot money from abroad that once momentarily left last year, has now in the second quarter come surging back in carrying 100’s of billions. According to statistics, at the end of June China’s total foreign exchange reserves totaled 2.13 trillion USD, of which a 177.9 billion USD increase came from the second quarter—the trade imbalance accounting for 43.7 billion USD and FDI (foreign direct investment) increasing 21.2 billion USD. According to the current way of calculating hot money, subtracting the increases in trade imbalance and FDI from the increase in foreign exchange reserves, yields an estimate of 122.0 billion USD increase in hot money.

Hot Money Surges in New Attack

According to China Academy of Social Sciences (CASS) Institute of World Economics and Politics researcher Zhang Meng’s analysis, if one deducts the estimated effect of Euro and dollar appreciation, it will explain 33.9 billion USD of the increase in foreign reserves leaving 90.0 billion USD of increase in foreign reserves that lacks a logical explanation—hence the only explanation is that it is the short-term inflow of international capital. According to statistics, from the start of the global financial crisis in October of last year to March of this year, there was a negative value to the inflow of international capital. But in February and March, there was a gradual reduction in the negative value, while in April it suddenly turned position, increasing 32.5 billion USD. May and June continue to increase at high rates.

Of especial importance is that in June the trade imbalance was only 8.26 billion USD, and actually used foreign direct investment was 8.96 billion USD, meaning that in that month the increase of 42.1 billion USD in foreign reserves there is potentially 24.9 billion USD that is entering as hot money. Bank of Communications department of development researcher E Yongjian thinks that there is evidence that hot money from abroad is entering with increasing speed and the liabilities ledger for the central bank is also showing the same trends—short-term international capital has started to increase in the speed of its return.

According to estimates from United Securities, over 120 billion USD in hot money streamed into China in the second quarter, exceeding the previous high point of 73.2 billion USD in the first quarter of 2007. Analysts point out that since March of this year, foreign reserves have been increasing nonstop but the trade imbalance and FDI increases have not clearly improved. The increase in foreign reserves is much faster than the growth in the trade imbalance or FDI meaning that outside funds are flowing in at high levels. United Securities analyst Liu Xiangning thinks the surge in hot money into China is mainly flowing into the property and stock markets—in the first quarter short-term international capital was flowing in at a negative number, and in the second quarter is has become a massive amount, meaning that the sensitivity of these funds is very high.

The poles towards which hot money from abroad flows are concealed. According to this reporter’s understanding, hot money often flows through multiple channels including individual layers and company layers. Individual layers mainly go through private conversion of foreign exchange—in Hong Kong, every individual can change 20,000 yuan (HKD change to RMB) and can remit 80,000 yuan RMB to the mainland. It often happens between Hong Kong and Shenzhen that, because many people are friends and family, there are special groups that convert foreign exchange like ants moving house such that a massive amount of hot money can move in very quickly.

In terms of company layers, the traditional channels for hot money such as “overstating export, understating import, and engaging in fake direct domestic investment” are gradually becoming marginalized. The new, emerging channels for entering the domestic area are technological service trade, importing of luxury items, trading in currencies, individual purchase of foreign currency, FDI capital projects, and underground money lenders [qianzhuang]. Experts point out that the operations of technological service trade and import of luxury items are secret and very difficult to regulate so they are a frequent choice when a large amount of hot money moves in. Currency trading is even more hidden from regulation and can allow hot money to move in both directions, and usually involves a large-scale multinational group that moves funds between its subsidiaries so it can move even faster.

In addition, the FDI approval rights issued by MOFCOM [Ministry of Commerce] might become a bigger and wider channel for the entrance of hot money. In March of this year, MOFCOM decentralized the approval and modification of companies started by foreign investors with registered capital of less than 100 million USD to the provincial level commerce regulators at the location of the company registration. The convenience provided to foreign capital will also provide a more convenient and lucrative operating channel for overseas hot money.

Lurking in the Housing Market

The specter of hot money started appearing in the first quarter in the housing market, and its momentum has intensified in the second quarter. Starting from March, property prices in first-level cities have increased across the board, increasing four consecutive months compared with a quarter earlier and surpassing the peaks of 2007. Part of the push raising property prices in first-level cities is investors from abroad. In addition to that of individuals investing in real estate, hot money also goes through different types of property investment companies and private organizations to enter the housing market.

A long-term study conducted by Centaline (China) Property Research Center shows that: from April of this year, of the three large groups of housing purchasers in Shanghai, namely Shanghaiese, people from outside provinces and cities, and people from HMT [Hong Kong, Macau, and Taiwan] and overseas, the proportion of Shanghaiese has decreased, falling a total of about 5% in April and May with Shanghaiese housing purchasers falling to 85% in May. At the same time, HMT people have taken over to become the nuclear force of the high-end property housing market in Shanghai. Starting from March, HMT housing purchasers increased 25%, 40%, and 43% over three months compared to the previous quarter, matching historical high points from former years.

Centraline property analyst Zhuang Wei expressed that while the market share occupied by people from overseas and HMT is not large, it is much more focused on high-end housing complexes, and places where they invest are sometimes “big money” transactions largely increasing the activity level in the housing market.

After the cancellation of “limiting outside commands”, the Shenzhen housing market has also started to be inundated with Hong Kong investors. According to an introduction by a representative of the Luohu port branch of Shi-Hua Real Estate, compared to April there has been an increase of 20 percent in purchases by Hong Kongers of Luohu port area properties, especially small- and medium-sized layouts of less than 70 square meters near Luohu port. At the Futian port, Futian central area, and Honey Lake [Xiangmihu] luxury residence area, Hong Kongers coming to invest in property have also increased. A China Securities Journal reporter recently visited multiple high-end housing complexes in Nanshan district and discovered that more than a few groups of people touring properties had Hong Kong accents, mostly focusing investment on areas and complexes with future potential to increase in value.

The general manager at the Shenzhen business department of Midland Realty, Jiang Shaojie, expressed that there are low interest rates at Hong Kong banks so funds are looking for roads to invest in the housing market, while at the same time there is a deluge of international hot money, making economically-sensitive Hong Kongers anxious over inflation. After the experience of the financial crisis, many Hong Kongers had severe losses from investment in financial securities hence real estate and gold investment are more in their good graces. But compared to 2007 when it buyers were unstrained with respect to properties, currently Hong Kongers in Shenzhen are reasonable and cautious in their purchases.

The development of the high-end residence market in Guangzhou has also felt the force of funds from abroad. Hopefluent market research department determined that, after 3 successive months in 2009 when the Guangzhou high-end market had approximately 10% growth, in May it sprand 18%. Conducting research on 46 mainstream housing complexes in the central area of Guangzhou, they found that 75% had already returned to 2007 levels. And among investors in these housing complexes, HMT and overseas buyers made up 30 percent and are growing.

Even in the realm of real estate development, restrictions on the entry of overseas capital are starting to being slackened. In May, the Beijing Municipal Land Reserve allowed guaranteed funds in foreign exchange to be used to land transactions, relaxing restrictions on the participation of overseas capital in land bidding.

The Future Might be More Rapid

The argument over whether, behind the dramatic climb in the domestic housing and stock markets, there lies the helping push of a large amount of hot money is currently ongoing. Professor Li Youhuan of the Guangdong Academy of Social Sciences thinks that hot money now is mainly concentrated in Hong Kong and Taiwan, and whether or not a large amount has entered the domestic market requires continued investigation. From April and May of this year, the dramatic climbs in Hong Kong and Taiwan stock markets and housing assets is related to a large influx of hot money, and Professor Li estimates that the scale of the inflow will grow in July.

Haitong Securities financial industry analyst She Minhua also expressed that the recent jump in global stock markets and commodities is mainly because of the strong predictions of economic recovery, along with predictions of inflation. “This is a relatively reasonable reaction. The gains in the domestic stock and property markets are not strongly related to speculative hot money.”

As the first stop in the build-up of international hot money, Hong Kong has relatively clear evidence of overseas funds flooding in. The newest research report from Citibank pointed out that, in the past two months, on average every week the funds flowing into Asian and especially flowing into Hong Kong have already reached the level of funds entering during the peak of the 2007 bull market. Sinolink Securities predicts that approximately 342.0 billion HKD of “hot money” has entered Hong Kong since September of last year, making up 50% of Hong Kong’s base currency, and vastly surpassing historical levels—and Hong Kong’s stock market has during this time recovered markedly.

Hot money has become a wave in Hong Kong and Taiwan, quickly raising the anxiety of whether a large amount of hot money will enter domestic areas. “Today, the eruption in the housing and stock markets has already being going on for some time, but from our inspections of flows in underground channels for overseas hot money, it has only been in June when a real turning point was reached, ending a span from October of last year to June of this year when net flows were outward—they have now turned net inward.” Guangdong Academy of Social Sciences Professor Li Youhuan expressed that in the last three months hot money mainly has been coming from the savings funds and some investment funds of HMT areas. Some overseas Chinese savings funds and a small amount of investment funds have started to enter the domestic market but currently there is no large-scale investment from international investment funds.

Li Youhuan thinks that, as far as the inspection of underground money channels, from April to June, every 10 days the amount of hot money flowing in shows a growing trend—and this has increased even further recently. Using the domestic and international economic development trends to predict, hot money flowing in will speed up in the second half of the year.

Different from the caution of domestic scholars, amidst the large-scale increase in the domestic stock and housing markets, large overseas banks emphasize that further development will become even more ferocious. A chief economic officer at a large overseas bank expressed that China’s housing market has already entered a period of growth, and the second half of the year will be auspicious for the real estate market. With excess liquidity and without a full recovery of the real economy, it is impossible for the government to mop up liquidity in the short term, so domestic housing prices will continue to rise. Unlike the first half of the year when rigid demand provided the impetus, the second half of the year operations from hot money will provide the key driving force in the increase of housing prices.

Zhang Meng, researcher at the CASS Institute of World Economics and Politics, thinks that in the second half of the year China will face an even greater surge in inflow of short-term international capital. With 7.37 trillion in new credit and loans supplied in the first half of 2009, if even more short-term international capital flows in, China’s asset market will be sandwiched between domestic and overseas excess liquidity making it very difficult to avoid a new bubble in asset prices. Of this we should be especially on guard.