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China's policy-induced property slowdown has put the central and local governments on a $320-billion US collision course in one of the economy's biggest growth-generating sectors.
Beijing wants local governments to bear most of the 2 trillion yuan ($320 billion US) cost to construct millions of affordable homes this year. This would offset a slowdown in private real estate investment as developers chop expansion plans following a state drive to curb property speculation.
Softer property prices, prompted by the crackdown, have stopped local authorities from selling land to raise money that's needed to build new homes and service debts they incurred during the central government's last stimulus program -- the 4-trillion yuan plan to combat the global financial crisis in 2008/09.
"As Chinese property prices fall, tensions are rising between cash-strapped local governments that want to pump up the market and a central government determined to preserve social stability by keeping a lid on housing costs," Rosealea Yao, an economist at Beijing consultancy GK Dragonomics, said.
Getting property right is crucial for China nationally as real estate investment makes up about 13 percent of economic output and the country's vast factory sector is battling with a downturn in external demand from debt-ridden Europe and under-spending U.S. consumers -- China's two biggest export markets.
Local governments must find a way to plug a gap in their finances. In 2011, their land sale revenue dropped 13 percent from the previous year to 1.86 trillion yuan, three domestic property consultancies estimated, and further falls are expected.
The predicament is leading local officials to try to flout property tightening measures and forcing Beijing to hit back hard whenever it sees something running counter to its core campaign to drive down runaway home prices.
That explains why the eastern city of Wuhu tried to relax home purchase restrictions on February 7 after its land sale revenue more than halved in 2011, only to suspend the plan four days later as pressure from Beijing and the domestic media rose.
An uneasy compromise could be hammered out if Beijing is prepared to turn a blind eye to some infractions that break the letter -- but not the spirit -- of calming measures. Such measures have taken nearly two years to gain traction, but now have delivered gently easing property prices four months in a row.
An example of one scenario for a mix of maintaining and easing cooling steps would be for local governments to keep slapping down multiple home purchases by an individual while cutting transaction taxes to revive a comatose market.
A showdown on the issue could come at China's annual parliament meeting in early March, where policies for the year are pinned down and local officials get their once-a-year chance to argue collectively with the top leadership.
The stakes are high as 2012 is a year of transition that will prepare for the formal stepping-down of President Hu Jintao and Premier Wen Jiabao. Xi Jinping and Li Keqiang are expected to move into their respective positions in early 2013.
At the local level, property is a major issue. Almost all local governments need land sales revenue to secure bank loans, repay debts, build state-subsidized homes and finance essential infrastructure projects.
In extreme cases, land sale revenue exceeds the total official income of some cities. Typically, the money raised through land sales is equivalent to 30-50 percent of a city's budget. Land sales have been a crucial way of supplementing official budgets.
Relaxing the campaign against property speculation would boost cities' revenue but be particularly problematic as Wen has made it a personal focus over the past two years. He faces public anger over the doubling of home prices in major cities in the wake of the 2008/09 stimulus-induced speculative boom.
"UNSWERVINGLY" TIGHT POLICIES
Wen has insisted that property-tightening policies will be followed "unswervingly" in order to bring down housing costs. That's even as evidence has mounted that banks are cutting loans to guard against exposure to a potential real estate bust that is hitting collateral values.
At the same time, external factors are curtailing investment inflows that otherwise support domestic credit growth.
Some analysts believe Wen has plenty of policy flexibility to respond if the sovereign debt crisis in the European Union -- China's top trading partner -- batters exports more than expected.
China's central bank trimmed banks' required reserve ratio (RRR) by 50 basis points on Saturday to pump liquidity into the economy, hours after data showed annual housing inflation eased in January to the lowest since real-estate tightening began in late 2009.
Further easing in housing and consumer inflation will create more room for RRR cuts if needed to combat a slowdown in economic growth, which slipped to a 2-1/2-year low in the last three months of 2011. For the current quarter, growth probably will dip below 8 percent a year, and 2012 may have the weakest full-year expansion in a decade.
Even if growth is falling significantly, Wen is likely to stick to his guns.
"We believe the central government will not ease its major property tightening measures in 2012," said Ting Lu, an economist at Bank of America Merrill Lynch in Hong Kong.
That means local officials, like those in Wuhu, will keep testing Wen's policy boundaries.
Chinese property consultancy CRIC said in a report last week that what happened in Wuhu could not eradicate market expectations for a relaxation of the tightening measures.
Beijing has already started tweaking policies, emphasizing most recently its longstanding pledge to support first-time home buyers, particularly through mortgage lending.
The central government has also allowed the cities of Beijing, Shanghai, Tianjin, Wuhan and Xiamen to expand the definition of ordinary homes in order to cut taxes for people who are still allowed to buy.
The cities of Dalian, Ningbo and Nanjing have also increased the amount of mortgage loans citizens can borrow from local housing provident funds, which offer much lower rates than commercial banks, at Beijing's consent.
If Beijing isn't willing to see its rules bent, local officials will have to cut land prices sharply to revive the stalled business, and Chinese developers will also axe home prices to sell their record inventory of unsold units.
That in itself could help restore life to the property sector and provide some cushioning against a bumpy economy.
"Falling land sale revenues will dent growth, but will not cause a hard landing of the Chinese economy," said Zhang Zhiwei, chief China economist for Nomura in Hong Kong.