Add this to your list of downside risks for Chinese economic growth this year

Johannes Eisele/AFP/Getty Images
  • The amount of failed land auctions in China spiked in the June quarter, hitting levels not seen in over five years.
  • Deutsche Bank says the increase provides an early warning signal on the outlook for construction activity and fiscal revenues at the local government level.
  • It expects Chinese policymakers will loosen monetary and fiscal policies and allow the Chinese yuan to depreciate in the second half of the year.

Tighter financial conditions for developers look set to weigh on China’s property sector in the second half of the year, according to Zhiwei Zhang and Yi Xiong, economists at Deutsche Bank.

Based off high frequency data, the number of failed land auctions conducted by local governments rose steeply in the June quarter, hitting the level seen in six years.

“It appears that selling land could become more difficult down the road,” the pair wrote in a note released late last week.

“We counted 226 instances of land sales/auctions that were unsuccessful in the past Q2. This was the highest quarterly number observed since 2012, most of which (160) happened in Tier 3 cities.”

The chart below from Deutsche Bank shows the pickup in failed auctions in the latest quarter.

Deutsche Bank

Tier 1 cities are the largest of the large with tier 3 or lower at the other end of the spectrum. The vast majority of residential construction activity occurs in China’s smallest centres.

Deutsche Bank says the lift in failed auctions sends an early warning signal about the outlook for construction activity and fiscal revenues at the local government level, even if still only a small proportion of total land sales.

“Failed auctions are still only a small share of all land auctions, about 6% in Tier 2 cities and 3% in Tier 3 cities,” it says.

“Nevertheless, it suggest a headwind against land sales may be emerging.

“Anecdotal evidence recently point to rising financial constraints developers face. Past cycles show that increased number of failed land auctions tends to coincide with sharp drop in land sales.”

Deutsche Bank

If this trend continues, Deutsche Bank says it will add to downside risks for economic growth in the quarters ahead.

“If land sales weaken in the second half of the year, it will add to downward pressures on growth, on top of slow investment and trade war tensions,” the bank says.

As such, it expects Chinese policymakers will take steps to ensure any potential slowdown in orderly in nature.

“We continue to expect the government to loosen monetary and fiscal policies and allow Chinese yuan to depreciate,” it says.

In the year to June, total social financing in China — the broadest measure of credit growth — grew by 9.8%, continuing to slow from the double-digit gains seen in prior years.

The People’s Bank of China said the slowdown was due to its policies to encourage deleveraging across the Chinese economy.

“The main drag continues to be off-sheet-lending, which dropped by 691 billion yuan in June after rising by 222 billion yuan one year ago,” said analysts at Macquarie Bank.

“Local Government Financing Vehicle and property developers could see the biggest impact from the deleveraging push, as they have high reliance on shadow banking.”

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