Quitting the Quota

HONG KONG – On March 1, China’s State Council announced a new batch of restrictions aimed at reining in property prices by curbing speculative demand. The measures include tighter limits on home purchases by non-locals in cities with excessive price gains, a reinforced 20% capital-gains tax, mandatory 70% down payments, and a 30% benchmark interest-rate premium for second mortgages.

While the previous round of housing-sector restrictions, implemented less than two years ago, dampened market sentiment temporarily, it failed to curb rising property prices. Likewise, although the latest measures might have some impact, cooling China’s turbulent property market – which relies on cheap credit – in the long term will require addressing underlying monetary-policy weaknesses.

In order to control the money supply, the People’s Bank of China (PBOC) has long used credit quotas as “window guidance” to banks. The policy is rooted in central planning, which, three decades ago, led to artificially low prices and, in turn, to shortages of basic necessities and key production inputs, such as grain and steel. As the free market developed, a dual-price system emerged, in which those with access to quota-allocated goods paid less. As a result, the government was compelled to grant subsidies to the system’s “losers” – such as urban residents and state-owned enterprises (SOEs) – until strong supply responses to rising market prices eliminated the need for quotas on manufactured products.

A decade later, in response to the global financial crisis, China loosened credit quotas and planning controls on SOE-run local-government infrastructure projects. Between November 2008 and June 2009, China’s banks issued more than ¥8.6 trillion ($1.3 trillion) in new loans. As a result, the rate of credit growth increased from 14% in September 2008 to 35% a year later, and property prices more than doubled in many cities.