Related stories

Measures on the Administration of Foreign Investment in Leasing Business Administrative Regulations on Foreign Investment in the Commercial Sector Regulations on the Establishment of Investment Companies with Foreign Investment 2004 Circular on Approval of Short-term Foreign Debt Quotas for Foreign-invested Banks in China in 2005 Letter soliciting public comments on the “Supplementary Circular Concerning Administration of Foreign Investment in Construction Enterprises”

Restriction on Foreign Investment in Property Market – Why?

Barely two months after the Chinese Government ordered measures on May 30 to bring soaring housing prices under control (Business Beijing, June 2006 issue), eight key central government departments jointly imposed restrictions on access of foreign investors to the country's property market.

In a circular dubbed "Document No. 171" for its serial number, the National Development and Reform Commission, China's economic watchdog, and the People's Bank of China, the central bank, and six other departments under the State Council, the cabinet, called for limiting some activities in the domestic property market. But experts were quick to note that long-term foreign residents in China, foreign property purchasers and businesses operating legally in China should not be affected.

Instead, the new foreign investment rules contained in Document No. 171, released by the State's Xinhua News Agency on July 24, target so-called "hot money"––short-term investments in China by people who do not live on the Chinese mainland or who do not operate legally registered companies here.

Such investments are blamed for driving up urban housing prices and distorting the property market which, if not checked, could pose a threat to China's economic stability.

Hot Money

According to the official press, local governments have also been preparing to implement new rules. The Beijing Municipal Urban Construction Commission on July 21 issued an "urgent circular," saying, in effect, that Hong Kong, Macao and Taiwan residents and returned overseas Chinese who are now living in the Chinese capital shall each be allowed to buy no more than one residence for their own use.

It may be necessary to note that under the "one China, two systems" policy, when operating on the Chinese mainland, companies based in the Hong Kong and Macao special administrative regions or Taiwan Province, though Chinese territories, are treated the same as foreign companies under the law. Likewise, some of the economic policies that govern the business activities of foreign nationals also apply to the people of Hong Kong, Macao and Taiwan living and working on the Chinese mainland, as well as returned overseas Chinese.

On July 27, a CCTV-4 commentator, quoting what she called the "Hong Kong press," reported, "In 2001, about 10,000 Hong Kong residents owned properties on the (Chinese) mainland. By the end of 2005, that number had shot up to 91,800, and it is expected to grow at 8 percent per year from now on."

As the mainland economy continues to boom, more Hong Kong, Macao and Taiwan residents and overseas Chinese are expected to settle on the Chinese mainland, whether they are business people seeking new opportunities, students, college graduates trying to find jobs, or retirees lured in by a relatively low cost of living.

But the real worry of the Chinese Government stems from the largely speculative purchases of housing, office spaces and buildings. According to a recent issue of the China Industry and Commerce Review, about US$4.5 billion in overseas investment was pumped into China's real estate sector in the first six months of 2006. This may be compared with US$3.4 billion for the whole of 2005. About half of the sum was invested in Beijing, 43 percent in Shanghai and the remainder, about 7 percent, was invested in provincial capitals such as Harbin, Wuhan and Nanjing.

It is no secret that, for years, Hong Kong, Macao and Taiwan-based investors, as well overseas Chinese, have been snapping up apartments, townhouses and villas on the Chinese mainland, but now new money is flooding in from Japan, the Republic of Korea, Europe and some oil-rich Arabian countries. Clement Luk, a director with Centaline (China) Property Consultants in Shanghai, was quoted as saying, "It really is crazy."

Virtually all properties bought by overseas investors in Beijing are "high-end" structures in the Central Business District (CBD) and other posh sections of the city. In Shanghai, entire office buildings have been sold to foreign investors. This has come at a time when pressure is mounting on China to revaluate its currency, the yuan, known as the renminbi.

Neither is there any wonder that the real estate sector is the main recipient of much of the illegal cash influx; it is the most profitable sector in the Chinese economy.

But speculation about the Chinese yuan, its valuation and convertibility is also playing a role.

Professor Yin Zhongli of the Institute of Finance under the Chinese Academy of Social Sciences said, "These two factors, working together, have prompted a larger-than-ever inflow of hot money for speculative, short term investment."

Back in March 2004, Zhou Xiaochuan, governor of the People's Bank of China, was quoted by Xinhua as saying that there "might be" some speculative inflow of funds gambling on a possible revaluation of yuan, but the amount of hot money "was not big." The picture is now drastically different. The yuan has been revaluated by about 3.3 percent since 2004 and is now valued at 7.977 yuan against the US dollar (as part of a basket of currencies used as a base). This compares to about 8.20 yuan to the US dollar before the revaluation. Some experts have predicted that the value of the Chinese yuan will continue to rise to about 7.8 yuan against the US dollar by the end of 2006. Within two years, the yuan could strengthen by as much as 6.7 percent with the 2004 exchange rate as the base figure.

Hand-in-hand has been a steady increase in hot money pumped into China by international speculators keen to take advantage of the yuan's revaluation. According to a National Statistics Bureau report, hot money inflows rose to about US$1.02 billion in January 2006 before increasing to US$4.45 billion in February, US$5.31 billion in April and a staggering US$12.50 billion in May. (Note: These figures, based on international practice, came from deducting the values of the country's foreign direct investment and trade surplus from increases in the country’s foreign-exchange-reserves, the report said.)

Experts assert it is obvious that the rush of funds threatens China's ability to absorb it. A "worst-case" result could seriously disrupt the country's money supply, creating a bubble that would affect the real estate industry and an array of others. Many have warned that this could touch off an inflationary spiral with global implications.

Professor Yin and other experts believe that a large part of the hot money influx, as much as 70 percent in Beijing and Shanghai, has gone to China’s property market.

The professor said, "The Chinese Government is totally justified in restricting overseas investment in the real estate sector, and the decision comes in good time."

In 2005, foreign direct investment (FDI) accounted for only 3 percent of the national total for real estate development, prompting some experts to assert that its influence on housing prices would be "very limited."

Now, Yin says, "We have to realize that in Beijing and Shanghai, foreign investors have already seized a significant share of local property markets. In Shanghai, it has already exceeded 10 percent."

"Mend the Fold"

In an interpretative article on the newly imposed restrictions on foreign investment in China's property market, Xinhua noted that of the 187 member countries of the International Monetary Fund, 133 have imposed restrictions on purchases of housing and other buildings by "non-resident" organizations and individuals.

It continued, "China needs to do the same to safeguard its long-term interests, given that its land resources are limited, relative to its population of 1.3 billion. Moreover, the (newly imposed) restrictions help curb profiteering speculation on the property market."

The Xinhua article said the latest decision of the central authorities in no way suggests that the Chinese Government intends to close the domestic property market to foreign investment.

Professor Yin Bocheng, director of the Real Estate Studies Center of the prestigious Fudan University, was quoted as saying, "The restrictions are meant to safeguard the stability of China's property and financial markets. Imposition of such restrictions is a measure to ensure a sound development of China's financial and property markets by following internationally applicable practices."

Gu Haibo, a self-employed property consultant in Shanghai, compared the restriction to a few twigs planted for building a "fence" round a place that should have been surrounded by a wall with a "gate" to allow people in and out.

"Only short-term, profiteering speculators, those engaged in 'hit-and-run' operations, will be denied access to China's property market," Gu said. "There is no discrimination against foreign-funded property companies operating in China on a long-term basis for lawful profits. The 'fence,' so to speak, will have an opening for such companies."

Basing itself on analysis and comments by these and other experts, the Xinhua article concluded that the new rules have three "unspoken words" or three things to imply. The first is that there has been too sharp an increase in the purchase of properties by organizations and individuals from overseas. In the first six months of this year, the article noted, 25 percent or more foreign-funded real estate companies were established on the Chinese mainland than in the same period in 2005, and foreign buyers spent twice as much on purchases of properties in Chinese cities. The second is that the country's rules for access to the property market are "far from being standardized." The third is that government controls and regulations have proven to be ineffective with regard to operations of foreign investors in the property market.

The Xinhua article said, "China has an urgent need to do something about these problems," and it quoted the Chinese proverb: "It's never too late to mend the fold even after the sheep are stolen."

In another interpretative article, Xinhua noted that the new rules are based on three principles. The first is the principle of "business presence," meaning that to invest in China's property market, a foreign company has to establish a corporate entity in China that engages in real estate development, and on no account will it be allowed to purchase housing and other buildings via their agents or representative offices in China. Under the second principle, apartments and other residential buildings purchased in China must be meant, exclusively, for use by buyers living or working in China. The third is the principle of citizen treatment, meaning that foreign investors operating on the domestic property market will, from now on, enjoy the same treatment as their Chinese counterparts.

"Until now," the article noted, "foreign-funded real estate companies operating in China have been enjoying a whole range of policy privileges with regard to allotments of land for construction, taxation and access to bank loans. The new rules are meant to correct this state of affairs in line with international practices."

High-end Property Market Affected

Experts agree that it is still too early to give a comprehensive assessment on how the new rules will affect the domestic property market. According to bits of information available to the author, however, most of them seem to agree on one thing, that is, in a year, the high-end property market will cool down.

Two reasons are given for the prediction: Foreign investors need time to adapt to the new rules, and it so happens that high-end structures are most favoured by foreign investors.

Chen Limin, an economist with the Shanghai Municipal Academy of Social Sciences, said, "I'm expecting a lot of small investors to pack and go over the forthcoming months. Those powerful enough to withstand the onslaught will have to change their business strategies."

The second lies in measures published by the central authorities on May 30 to curb soaring housing prices. Those measures call for discouraging construction of "luxury" homes by banning the construction of "villas" and obliging developers to use not less than 70 percent of their land allotments for the construction of "affordable, economy-class" homes, homes smaller than 90 square metres each.

But will the new rules effectively bring down housing prices?

Chen told the China Industry and Commerce Review, "If all goes well, the new rules may help curb the rate of increase in housing prices."