China Moves to Temper Growth; Property Bubble Is a Key Concern; The realization that leaders are retightening screws surprised market

Updated March 4, 2013, 7:49 p.m. ET

China Moves to Temper Growth

Property Bubble Is a Key Concern

By TOM ORLIK and ESTHER FUNG

BEIJING—China set a growth target of around 7.5% for this year as it kicked off a meeting to finalize its leadership transition, reflecting how Beijing is turning away from breakneck growth based on exports in favor of a broader economy driven by spending at home. China’s ambitions for more moderate growth come after decades of double-digit increases and are a centerpiece of new leaders’ plans to be detailed during the annual National People’s Congress, which began Tuesday. Beijing’s broader goal is to shift the economy away from reliance on investment and exports, with a stronger role for domestic consumption, as it kick starts painful reforms to rebalance the country’s economic model. In the days leading up to the legislative meeting, China’s government aggressively struck at once-again-surging housing prices, showing leaders’ determination not to let a property bubble push the economy off track or breed dissatisfaction with the government just as a new guard is taking over. The growth target maintains the goal for stable growth set out last year and isn’t a forecast—China routinely exceeds its targets. Last year’s growth was 7.8%. During the National People’s Congress, eyes are on the new leadership under Xi Jinping, the Communist Party chief to be named president during the meeting, to see whether it will go beyond rhetoric to make the difficult changes required to raise household income and boost consumption spending.

A bubbly property sector has been a key feature of China’s unbalanced growth. Rising house prices drove overinvestment in real estate, and also crimped consumption by forcing households to scrimp and save to get their foot on the housing ladder. Leaders have worried about social frictions caused by housing that is out of reach for average earners. The renewed controls to tame the property sector, a major contributor to growth, suggest the government is prepared to safeguard the gains from three years of attempts to make buying a home more affordable for the middle class—even if it dents the growth outlook. The realization that leaders are retightening screws surprised markets, which like many property buyers had concluded that leaders were satisfied with the results of repeated tightening and willing to tolerate a gradual return to rising prices and sales.Shares of Chinese developers plummeted on Monday, the first day of trading after policy makers said on Friday that they will strictly enforce a capital-gains tax of 20% on profits from home sales. China’s State Council, or cabinet, also said it would reinforce controls on who is allowed to buy a home and push banks to raise down-payment and mortgage rates for second-home buyers in some cities.

The repeated tightening had resulted in prices leveling out. But in the past few months, house prices in China’s top-tier cities have again started to rise at alarming rates. Average prices for property in Shanghai were up 41% from a year earlier in the first two months of the year, and Beijing prices are also rising fast, according to data from real-estate agency Soufun.

“The government has not been able to break the cycle of expectations pushing prices higher and driving higher expectations. Someone has to get hurt, to convince people China’s property is not a surefire bet,” said Mark Williams, China economist at Capital Economics.

Shenzhen-listed China Vanke000002.SZ -1.01% Co, China’s largest developer by volume was one of several property stocks to plunge the daily 10% trading limit Monday. The property hit helped drag China’s benchmark Shanghai Composite Index down 3.7% for the day. Mainland developers in Hong Kong also fell sharply.

“To head off economic and financial risks, and to show it could achieve its own objectives on controlling prices, the government had to act,” said Louis Kuijs, China economist at RBS.

The recent uptick in property prices had raised questions about whether policy makers can deliver a more permanent solution to the problems of the housing market. Reaction to the latest moves in Shanghai was that they were likely to have a strong effect.

“Home prices will definitely take a hit once the new regulations are in place,” said Chen Jun, a real-estate agent at Haiyu Dichan, a property agency in Shanghai.

Some Shanghai residents looking at investing in property saw the capital-gains tax as a strong limiting factor.

“I was talking about these curbs with my friends and I think we would be better off investing in U.S. real estate,” said Terry Li, an executive at an IT firm.

Developers also took the move as a sign of the central government’s determination to tighten the market. It “strengthens our view on the long-term nature of the property curbs,” said a spokesman for China Vanke.

The measures to quell housing costs since April 2010 have left China’s central government in a game of whack-a-mole with real-estate developers, local governments and speculators—all of whom have an interest in continued rapid increases in prices.

Leaders’ efforts started to bring house prices back into line with income but did little to address the fundamental causes of China’s property bubble, analysts say. Limited alternative investment options for households, local government reliance on land sales as a source of finance, and the persistent belief that China’s house prices can only go up meant the pressure for unsustainable rises in prices remains.

The latest moves appear aimed at preventing sharp increases in home prices spreading from China’s first-tier cities to provincial capitals and smaller cities, where prices remain subdued. “The evidence is that prices in second-tier cities follow the top tier with a lag of a few months,” said Jinsong Du, China real estate analyst at Credit Suisse. “The government wants to get ahead of that.”

Property developers face the prospect of slower sales. Yuzhou Properties Co.,1628.HK -1.52% a developer in the southeastern city of Xiamen, said the new rules would delay the launch of their high-end homes. “We have to wait for an opportune time to launch the villas,” said Leo Yang, investor-relations manager. “You can’t possibly launch it when the country is going through a tightening phase.”

The State Council has promised to expand China’s nascent property tax, currently being tried in Shanghai and Chongqing. A nationwide tax would dent the enthusiasm of speculators by increasing the cost of holding property. But finding adequate new sources of revenue for local governments, and alternative investment options for households, remain intractable problems.

Many analysts expected rising property sales and investment—the biggest single source of China’s domestic demand—to provide a tailwind to growth into 2013. But a weaker property market will hit demand for everything from steel to furniture and a car to park in the garage. Commodity exporters like Australia and Brazil, which feed China’s steel mills, could also suffer.

Real-estate developers come into the downturn with their balance sheets relatively robust. “The listed developers had strong sales in 2012, and also raised debt in the bond market,” said Mr. Du, the Credit Suisse analyst. “They are saying that local governments will go bankrupt before they do.”