Chinese authorities refuse to hike interest rates because they fear that will cause the bubble in the real estate sector to burst, suggests Andy Xie, Morgan Stanley's chief economist for Asia-Pacific.

"But, with the renminbi's currently low interest rate, at 1.98 percent annually, there will be new waves of real estate speculation, which will eventually lead to the bursting of bubbles within the real estate sector," said Xie.

"That would be a real disaster!"

Xie's admonitions are contained in a report, which he wrote recently. The report was translated into Chinese last week by several Chinese media outlets.

Xie's remarks constitute the most serious warning to China's real estate sector. The industry has grown rapidly, with soaring prices, in recent months.

Xie also asserted the US Federal Reserve's policy of maintaining low interest rates, combined with China's low interest rates, often results in bubbles within China's real estate sector.

Low interest rates in the United States have prompted many investors to channel their massive amounts of capital to China, where, given China's low interest rates, the money has been used for real estate speculation.

Xie's admonitions echoed comments, last summer, by Stephen Roach, Morgan Stanley's chief economist, who said 25 percent of the nations' economies, including China's, suffer from full-blown housing bubbles.

Yi Xianrong, a renowned economist with the Chinese Academy of Social Sciences, agrees with Roach.

Xie and Yi contend the Chinese Government must increase interest rates in the near future to avoid inflation -- and bubbles within the real estate sector.

Statistics appear to back up their argument.

National Bureau of Statistics (NBS)'s figures indicate investments in real estate development rocketed 28.8 percent, year-on-year, to 718.5 billion yuan (US$86.73 billion) in the year's first eight months.

The growth rate in investments was 0.2 of a percentage point faster compared with the year's first seven months.

Between January and August, 369 million square meters of new properties were built, up 13.7 percent year-on-year. By the end of August, there were 96.95 million square meters of vacant properties, down 0.8 percent from the same period of last year.

In August, the average property price in China rose 13.5 percent, year-on-year, to 2,749 yuan (US$331.20) per square meter.

Yi suggested the Chinese Government's current land policies and credit-tightening measures have played less role in the real estate sector compared with other industries.

"We must be careful that real estate developers do not use the harsh policies as an excuse to raise their prices," Yi said.

Real estate developers, researchers and several government officials have refuted the three analysts' opinions.

Last week, the Ministry of Construction's Policy Research Center released a report -- widely considered an official response to the admonitions by Xie, Roach and Yi -- on bubbles within the nation's real estate sector.

"When the property market is supported by residents' real demand for housing, the partial overheating in the sector can be branded as a bubble," the report argued.

China has 490 million urban residents. That figure is expected to rise to 800 million by 2020.

Between now and 2020, an estimated 350 million people will need new housing, and an estimated 27 million urban families will need larger homes, the report said.

That demand, the report continued, will support growth in China's real estate sector for several years.

The proportion of speculative investors in China's real estate sector, particularly in housing, is very small. Most of the home buyers are making purchases for themselves.

For example, purchases of housing for investment purposes in Shanghai -- the highest proportion in China -- is only 16.6 percent, the report said.

The report also argued the so-called high vacancy rate -- estimated at 20 percent, compared with the international average of 15 percent -- is not necessarily a sign of a housing glut.

In China, the vacancy rate includes all unsold properties; in the West, it includes unsold properties in a one-year period.

The recent boom in China's real estate market does not necessarily mean the vacancy rate will rise. In Beijing, for example, there have been long lines, since the beginning of the year, of potential buyers ate virtually every new housing development.

The Ministry of Construction suggested, in the report, that fast-rising property prices were due mainly to rising land price, which resulted from the recent adoption of the public land transfer system.

A reduction in the supply of budget housing, with beneficial tax treatment, also contributed to rising property prices.

Beginning on August 31, in accordance with a circular from the Ministry of Land and Resources, all land transactions must be completed through either an auction or public tender.

It is widely believed that the system has, at least in the short term, boosted property prices.

In China, all non-agricultural land belongs to the State, but developers and residents can purchase, and trade, land-use rights to properties. Land-use rights generally last for 70 years.

The average land price in China, during the year's first half, rose more than 11 percent.

Pan Shiyi, chairman of SOHO China Co Ltd, a leading real estate developer, said earlier this month that rising property prices have been the result of rising land prices, the government's credit-tightening measures and surging demand.

The People's Bank of China, the nation's central bank, has not tipped its hand, despite the swirling debate.

"The issue of interest rate hikes is too complicated to be dealt with by us," said Philip Wu, housing director of property consultant DTZ Debenham Tie Leung's Beijing branch.

"But in terms of pushing down so-called real estate bubbles, commercial banks, under the current credit tightening, have designed various tools to prevent financial risks associated with mortgages. There apparently is no need to increase interest rates.”

(China Business Weekly October 26, 2004)