ASIA VIEW:On alert

It has been a challenging year for the world’s second-largest economy, with slowing growth, subdued consumer demand and an ailing property market keeping the Chinese leadership on its toes and the global markets in a cautionary mode.

However, the chaos that erupted after last month’s stock market crash, and the resulting scurry of policy measures that included a surprise 3 percent currency devaluation, has sent financial markets into a tizzy. Theoretically speaking, the domestic real estate sector ought to come out on top as the preferred investment class amidst all the disruption, but that is unlikely to happen. If anything, this will further aggravate the ongoing capital flight into overseas real estate.

For the 12-month period ending in June, the Shanghai composite index recorded a dizzying 150 percent increase, largely on account of a rise in margin trading. By mid-June, the bubble had burst and three weeks later, the index had fallen 30 percent, wiping out over $3 trillion from the value of the Chinese stock exchange. Expectedly, the Chinese government intervened to abate the panic by decreasing the interest rate, suspending trading of certain stocks, and lending to brokerages for purchasing stocks, but the Chinese stock market has continued to remain volatile. On July 27, following a few days of stability, the market suffered its biggest daily percentage decline since 2007, when the index fell 8.5 percent.

China’s stock market is mostly led by individual retail investors and many will now be prompted to switch to real estate investing. A recent survey of the investment plans of Chinese households, first published on Bloomberg Briefs, has suggested that following the market rout, investors in stocks are 50 percent more likely to move out of stocks to buy property in the second quarter of this year.

Investments in overseas real estate will be the preferred route. As part of wider financial reforms, Chinese authorities have been implementing many cross-border investment schemes such as a Qualified Domestic Investment Enterprise (QDIE) license – a scheme launched early this year allowing mainland asset managers to set up funds in a free trade zone for overseas investments.

It is generally hard for an average Chinese to invest money outside the country, because of legal limitations on investing RMB and the hurdles of currency conversion, but via such schemes, investments in offshore markets can be made more freely. In early August, a Chinese microlending firm, CreditEase, was among the first domestic firms to set up a private equity real estate vehicle via such a scheme. The $150 million vehicle, structured as a fund-of-funds, is seeing a lot of demand from domestic high-net-worth investors. Similarly, the Qualified Domestic Limited Partnership scheme in Shanghai currently allows international hedge funds to raise RMB capital from mainland investors for overseas investments, but its scope is expected to be eventually widened to include private equity funds as well.

The 3 percent devaluation in the Chinese currency will not do anything significant to reverse this tide. Chinese investment into the US real estate, for instance, will dampen only if a much more significant 10 percent to 20 percent devaluation occurs, according to a report by Colliers International.

Investment in the domestic real estate market, however, is a different story. Cheaper RMB technically means lower capital investment costs for overseas investors into China’s real estate, but investment decisions are not taken solely on the basis of currency exchange risks. Indeed, several fund managers have told PERE that the ongoing macroeconomic instability has made them put all fundraising plans for China on hold.

Even the glimmer of hope shown by a revival in home sales in some Chinese cities was snuffed out by last week’s investment data from China’s National Bureau of Statistics. At 4.3 percent growth, new investment into real estate in the first seven months of 2015 has been estimated to be the lowest the country has recorded since the 2009 economic crisis, the bureau said.

One could argue that these are short-term blips, and the government still has enough monetary easing power to maneuver growth and keep its two “hot potatoes”, a term used by a local real estate broker for the equity market and real estate, under control.

That said, the crisis of confidence and credibility the current government is facing will be hard to contain. Whenever the government interfered in the past, the market immediately rebounded. This time, it took three days to temporarily halt the index’s slide and the ensuing panic. That’s something that has never happened before.