Photographer: Justin Chin/Bloomberg

The Jump in China's Housing Starts Could Be a Huge Head Fake

Local governments may be hitting up developers for revenues, Macquarie says.

At first glance, it makes perfect sense: Chinese property sales surged in March, and new housing developments rose in tandem with resale activity.

But a peek under the hood from Macquarie Capital Ltd. analysts led by Ian Roper suggests there's reason to be skeptical about China's presumptive rebound in residential investment.

In March, national total floor space sold and the floor space of houses newly started rose 38 and 27 percent year-over-year, respectively. But the analysts observed that during the first quarter as a whole, there were many instances of a distinct mismatch between sales growth and so-called starts at the provincial level. In particular, some bulk commodity-producing locales like Xinjiang saw starts outstrip sales by a massive margin:

Source: Macquarie

This development lends support to a potentially worrisome dynamic: faced with a slowdown in growth, Chinese policymakers are backsliding on their quest for rebalancing of economic activity towards domestic demand.

"This regional discrepancy between new starts and sales is somewhat counter-intuitive, and more importantly, it probably runs against Beijing’s target of property destocking," the analysts wrote. "The central and western provinces (particularly the resource-rich ones) have been hit hard by the slowdown of the whole economy; as a result, existing property stock may be harder to be absorbed in these provinces; another wave of new starts clearly doesn’t help to resolve the issue of existing housing inventory."

However, Roper & Co. point to another reason for the puzzling composition of China's housing strength. The looming value-added tax reform, which begins to go into effect on May 1, may see some of the revenue generated from housing starts siphoned away by the central government. The analysts speculate that local governments may have been leaning on developers to break ground ahead of this policy change in order to prevent further erosion of their tax bases.

"Beijing will probably work out a transition plan to ensure local interests don’t get hurt too much, but the uncertainties of the final implementation may still have compelled some local governments to take measures to protect their tax income," the team writes. "One possibility is that they may have pushed local property developers to advance project starts, and the implication is that actual construction activities may turn out to be somewhat less strong than the National Bureau of Statistics data suggest."

The upshot, according to the analysts, is that the demand for commodities implied by this spike in starts—particularly for steel—may be overstated in the near-term if many of these starts turn out to be phantom activity that was advanced at the behest of local authorities.

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