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Thursday 17 February 2011

Unit 2 & 4: Combining monetary and fiscal policy to curb inflation in China

Inflation is rising in China (click here for BBC article), and many of the reasons are the same as those given by Mervyn King for the rise in the UK - food prices are up 10.3% and the producer price index has risen to 6.6%, giving an annual inflation rate of 4.9% in January.


This is in spite of three interest rate rises in the last four months, and has brought about a further rise from 5.81% to 6.06% by the Central Bank.


The growth of the property owning middle class is recognised as having a role here - the National Bureau of Statistics also announced changes in how it calculates consumer price inflation.


In spite of the fact that there is still a huge proportion of the population who live on a very low income, and poor families spend up to half their incomes on food, housing has now been given a much larger share of the new consumer price index (CPI) basket, and food prices have been given less weight, it said.

The problem of huge growth in the housing market is also being addressed, with a sharply targeted new tax on second homes in Shanghai and Chongqing. Most buyers of these homes are paying cash, so demand is completely unaffected by changes in the interest rate and some other method of curbing excess demand was needed. The tax, paid annually, is being applied differently in each of the cities.

In Shanghai, buyers of second homes will pay an annual tax of between 0.4% and 0.6% of the purchase price, depending on how the price compares with market averages. In the south western city of Chongqing, the tax is more staggered, ranging from 0.5% to 1.2%. Here, the property tax will only apply when second homes purchased by families take the total space of the two properties to a gross total that exceeds 60 square meters per person in the family.

The tax will be levied on the area that is in addition to the allowable 60 sq m per person. The city’s mayor, Huang Qifan, said that while it was “impossible for housing prices to fall overnight because of the property tax”, it would “help to curb speculation in the housing market”.

There is an interesting mix of state and regional policy being used here. ChinaDaily reports that “Lu Qilin, deputy director of the Uwin Real Estate Research Center, said the tax will mesh well with other initiatives to cool the property market. “The property tax will lead the housing price downward together with the impact of the new housing regulations released by the central government earlier,” Lu said. On Wednesday, the State Council released a regulation to cool the nation’s housing market, including raising the down payment needed to buy a second home to 60 percent from 50 percent. Lu told China Daily many speculators will likely choose to buy investment homes in other cities and the cost of homes in Shanghai could fall by as much as 10 percent as a result.”

For more comment on the way in which the tax may work to change behaviour, see this report from the BBC. The ultimate aim of the tax was to prevent hoarding of properties, rather than to rein in prices, according to Michael Klibaner, head of China research for property company Jones Lang LaSalle. “Previously there was very little holding cost for residential property because many people paid 100% cash for these properties. Now the holding cost is no longer zero,” Mr Klibaner said. “When the holding cost is zero, it’s very easy to let these homes sit idle. It doesn’t cost you anything to let them sit there. “Now there’s a holding cost - the hope is it will change the way people perceive real estate as an asset class.”

A wider ranging report on the positive and negative externalities associated with China’s huge growth, this one, again from the BBC, looks at the relatively unknown city of Wuhan which has set itself a target of 12% annual growth. One result is that property prices have risen so much that the average apartment now costs about 29 times the average salary there. Another is that the pollution is such that you cannot see from one side of the river to the other.

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