What No One in the West Knows About China's Economy

The Chinese government announced recently that in April this year, property prices in China fell 25% compared to April last year.

Following this, data in May showed that of the 70 cities surveyed, 35 of these recorded month-on-month drops. That was compared to the previous month, when prices dropped in only eight cities.

It’s taken almost four years, but the lending restrictions by the People’s Bank of China — China’s central bank — seems to have cooled the property market. To prevent property speculation from driving house prices up, the central bank imposed a 60% minimum deposit for second homes.

This has slowed housing purchases in recent years.

But here’s the thing. Although it may have curbed speculation, there is a downside. Property related transactions in China can generate up to 40% of local government revenue…

Because of this, many local governments in the Middle Kingdom are taking action to beef up their revenue again.

Several cities, including Nanjing, loosened the standards for home loans. However, this hasn’t had much effect at restimulating demand. Tongling introduced a concept similar to Australia’s First Home Buyers Grant. They called it the Home Provident Fund. But again, the move did little to boost housing purchases.

And while the central bank is making the loan application process easier, it’s not lifting the restriction for now.

That means local authorities need to come up with their own ideas on how to drive home sales.

Surprisingly, they’re looking to adjust to the rules on owning a house. But this involves changing a system that’s been in place for centuries.

Let me explain…

Understanding the System

Hukou is a registration system in China. And sometimes it can be a residential permit of sorts.

You see, without the local Hukou, many new migrants to a town can’t buy a house without meeting certain requirements.

While Hukou is officially a ‘registration system’, many consider it to be a caste system. It’s a way of keeping everybody in appropriate social economic classes. In other words, it’s to keep people in their place.

To fully understand the concept, during a recent video interview I asked our emerging markets analyst Ken Wangdong what Hukou means:

‘Hukou system is very unique. It’s a citizen registration system. It’s compulsory. You become a part of it when you are born.

‘It’s like passport. Imagine you had state level passports in Australia. You travel to Sydney with a Victorian passport but you can’t get the state level New South Wales benefits to the full extent.’

According to Ken, it’s incredibly difficult to transfer your registration to a new area. ‘You would need sponsorship from a powerful company, like PetroChina for example,’ says Ken. ‘The disadvantage of the Hukou system is if you want to travel somewhere else you don’t get the full advantage of that province or state.’

Some of those benefits include which school kids can attend. While kids can attend a local school in a new province, Ken said that a new citizen would have to pay a sponsorship fee for their child to attend the government school. Locals on the other hand wouldn’t have to pay that fee.

In other words, because of Hukou, new residents can’t access the benefits the provincial government may provide.

But that’s not all. The complications continue for new people in a city.

The House of Hukou

To buy a home, Chinese citizens need to live in one province for at least five years. And they must have the tax records to prove it.

This Hukou system is actually starting to hurt the Chinese property market. As Ken told me, ‘to some extent it has discouraged people from settling permanently in urban areas’.

Because local government derives much of its income from property, some are willing to alter the Hukou requirements for local home ownership.

The China Daily reported this week:

‘…Central China’s Wuhan city eased its household curbs to allow older college graduates working in the city to settle locally, a move expected to attract 100,000 graduates, hopefully boosting property purchases.’

Some in the press have dubbed it the ‘House for Hukou’ plan.

Chinese authorities are already aware that Hukou restrictions are holding back urbanisation in general. In March this year, Premier Li Keqiang confirmed that over 100 million people would gain Hukou status by 2020.

To you and me, this information might seem irrelevant. How does a class system in another country affect your investments?

However, these structural changes to a centuries-old way of life will alter the Chinese economy in the long term.

Clearly China, under the guise of progress, is willing to shake up a system to keep their economy growing.

The policy change will have a big impact on China’s economy. And yet no one (except one well-connected insider) in the West is writing or talking about it. Why? Most likely because they don’t know about it or don’t understand it.

But as an investor, understanding the internal politics in another country is vital to making good investment decisions. You can’t invest in the market without knowing this stuff.

That’s why Ken Wangdong has joined the Money Morning team, to add the kind of in-depth and inside analysis that no one else can provide. Look out for more from Ken in the coming weeks as he shares more of his analysis on emerging markets with Money Morning readers.

Shae Smith+
Editor, Money Weekend

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