Out of carrots, time for sticks

There is a Chinese idiom that goes: “The sky is high and the emperor is far away.” In the days when emperors ran China, the meaning of the phrase was self-evident to every ambitious bureaucrat: the further you are from the ruler, the greater your freedom of manoeuvre.

Imperial mandarins knew that administrators in China’s southern provinces were the most likely to turn a blind eye to official policy – thanks to their distance from the Dragon Throne. They were particularly likely to deviate if it served their local interests.

The idiom lost much of its relevance when Mao Zedong took power in 1949. Through sheer force of will he consolidated the power of the central government, and made sure his writ was enforced in even the most distant provinces. The emperor was never far away when Mao ruled China.

However, after his death and three subsequent decades of economic reform, the idiom is making a comeback. The biggest shock of all came last week when the city government in Beijing defied the central government. As reported in WiC53, it held a record-breaking land auction, flaunting a central government directive to rein in the nation’s property market.

The fact that state-owned firms were also the parties bidding on the land only made matters worse. The China Daily complained that the auction “sabotaged the central government’s efforts to prevent housing bubbles” and made a mockery of the leaders “tough talk” about “excessive home price hikes”.

It is against this background that a recent Sasac announcement must be understood. In a swift reaction to Beijing’s land auction it barred state firms from any involvement in the property market.

Why did Sasac make the announcement?

Nobody likes being ignored, and especially not the leaders of China. But with the city of Beijing’s provocative act, it was evident to all that a new low had been reached in the relationship between central and local government. This wasn’t some errant distant province: this was Beijing. The ‘the emperor’ doesn’t get any closer.

The country’s leaders needed to send a message fast. That’s where Sasac’s announcement comes in. Sasac (see WiC45) is the body that administers China’s state-owned enterprises (SOEs). It isn’t normally prone to the theatrical, but when it ordered 78 SOEs to quit the property market this week, the news dominated headlines.

The move served two purposes. First – lest anyone was in doubt – the central government was making clear who was boss. By getting Sasac to ban so many SOEs from this sensitive area it gave warning to bureaucrats all across China that it made the policy decisions and not local governments.

Aside from this none-too-subtle message, the move was also intended to calm the frothy property market. The Financial Times commented that “[the Sasac] ultimatum is the latest policy aimed at curbing the red-hot property market and reining in the so-called ‘land kings’ – mostly state-owned companies that in some cases are paying more per square metre for undeveloped land than the market price for nearby apartments.”

Does the ban make sense?

For those that believe there is a housing bubble, the answer is yes. Removing so many SOEs from the property market also removes a big source of liquidity. And not a welcome source either: many local commentators had viewed them as little better than speculators. Most of the firms had no experience in property development. What they did have was ready access to cash – thanks to the massive surge in bank lending that accompanied the government’s stimulus package. As state-owned firms, banks viewed them as low credit risks and happily lent them money. This was used to bid up the price of land, particularly in cities like Shanghai where it is estimated property values rose 50% in 2009.

Private sector property developers were angered by the situation – all too often they were priced out of land auctions by SOEs gorged with cheap loans but with little or no knowledge of how to profitably develop the plots. By outlawing such firms from bidding on real estate, it is now hoped that the market will become less bubbly.

What happens now?

Sasac has told the 78 firms to stick to their core business. By April, they must announce plans to exit the property sector.

Shipping firm, Cosco has already made its intentions public. According to a Xinhua report, the SOE plans to sell its 8% stake in property developer Sino-Ocean Land to conform with the new regulations.

Are there any exceptions?

Yes, there are 16 state-owned firms for which property has been deemed a ‘core’ business. They will still be allowed to participate in the real estate market.

But notably missing from this list are Citic and China Ordnance Industry.

That’s likely no coincidence: they were two of the firms that bid in the controversial Beijing land auction that irked the government. In fact, Citic paid Rmb5.25 billion ($769 million) for a site in Daxing. That’s the single highest amount ever paid for a piece of land in Beijing.

As one of the 78 firms kicked out of the property market, Citic ‘s days of breaking records in land auctions look to be over.

Will the measure work?

It should remove some of the speculative froth; but perhaps not as much as first thought. The 16 SOEs that will remain active accounted for 86% of the all real estate developed (and sold) by state-owned firms in 2009. That suggests the other 78 firms were quite minor players.

And who are the 16 ‘permitted’ companies? Some are unmistakably property firms, such as China National Real Estate Development Group. But it’s a little harder to say the same for some of the others. Take COFCO – the China Oils and Foodstuffs Corporation. It makes 80% of its profit from things like grain and edible oils.

Its property arm has been financed by foodstuff profits, and revolves around its Joy City concept, in which COFCO combines residential housing with giant malls – in which it locates its supermarkets and then, in turn, sells its foodstuffs. The company’s management argues that this is synergistic since it straddles the two basic human needs of food and shelter. COFCO wants to spend Rmb80 billion ($11.7 billion) over the next five to 10 years building 20 more Joy Citys around China. That’s a grandiose vision and it may not reassure those who still worry about a property bubble…

Nor perhaps will the fact that Sino-Ocean Land has eluded the Sasac cut. Previously regarded as a state-owned developer – which no doubt helped it access bank financing – it was another of the companies that set a record in the recent Beijing land auction. It is described by the South China Morning Post as “one of the most aggressive property players”. However, its CFO Adrian Sum told that newspaper that since no individual state firm owned more than 25% of its stock, it was not deemed a state-owned developer, and hence escaped the new regulation.

Sino-Ocean’s appetite remains undiminished: this week it reaffirmed its confidence that it would hit its 2010 target and sell Rmb20 billion of property during the year. That target, incidentally, is 40% higher than last year’s.

In fact, with many of the ‘Big Beasts’ of the property industry still active, the real market impact of Sasac ruling’s may be more psychological than practical. Realising this the country’s leaders have waded into the fray yet again: on Tuesday local governments were forbidden from selling any more land for residential use till April, when a new land supply plan will be announced.

That should take some heat out of the market – for a short while.

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