The era in which Chinese homebuyers can purchase bricks and mortar with cheap mortgages could be coming to end as a result of last month's interest rate rise for bank lending.

The move, which is expected to guide the nation's overheated economy towards a soft-landing, may exacerbate Chinese borrowers' financial balances although this is yet to become too much of a burden.

The People's Bank of China, the nation's central bank, increased interest rates for the first time in nine years starting from October 29. The benchmark rate for one-year renminbi loans was lifted to 5.58 percent from 5.31 percent and the rate on one-year deposits to 2.25 percent from 1.98 percent.

While the implications of the rise continue to be discussed by experts, another debate on whether Chinese families are burdened with too heavy a debt portfolio is starting. Research conducted by Liu Jianchang from the Chinese Academy of Social Sciences (CASS) said the so-called household debt ratio, or the proportion of household debt surplus compared to disposable income, in some major Chinese cities has increased massively. Others claimed that the statistics from the research are doubtful and said the debt burden of Chinese families is not so heavy.

Liu said families in some big cities have seen their household debt ratio rise to or near 100 percent, which will prove to be an unsustainable borrowing binge. In Beijing, the ratio is 122 percent and in the red hot real estate hub of Shanghai, the ratio is as high as 155 percent. In comparison, the ratio is around 115 percent in the economically advanced United States. Liu conducted the research on the basis of disposable income, population and individual credit statistics released by the National Bureau of Statistics (NBS).

Some other economists, however, said Liu seemed to have overstated the extent of the problem, arguing that the statistics may not be accurate given Chinese people's hidden incomes, which is high in prosperous cities. They also said the momentum of the household debt increase is on the decline, which may result in long-term financial security.

Moreover, they said the high debt ratio does not automatically spell disaster for the expanding Chinese economy.

Statistics are a crucial factor behind the divide. Although China has adopted the real name deposit system in 2000, it still has many loopholes through which many people could manage to conceal a significant amount of their hidden incomes. The lack of accurate figures in this respect does shake the basis of Liu's argument, although not fundamentally.

Liu's warning about household debt levels, however, is no economic equivalent of crying wolf. It poses a serious question: Can we sustain a house-purchasing pattern that is based on a high household debt ratio?

From January to September this year, the prices of commercial houses rose by 13.9 per cent year-on-year across the country, according to the NBS. Continually increasing real estate prices has posed a threat to the financial security of some families. In Shanghai, for example, the average price of commercial houses was 5,118 yuan (US$616) per square metre, while the annual per capita disposable income was 14,867 yuan (US$1,791). Even taking into consideration some amount of hidden income, the price remains disproportionately high.

Zuo Dapei, a researcher from the CASS, said the average price of an apartment in advanced economies is roughly 3-4 times the average household's annual income. In China, it could be 8-15 times the income of an ordinary family.

Then how can so many families afford to buy houses with mortgages? The answer mainly lies in the low interest rate and the expanding economy over the past decade. Consumers can put down a 20 percent down payment and make monthly mortgage payments at rock-bottom interest rates in the coming years. The policy makes it easier for many people to realize their dream of owning their own home, a result of which is individuals taking on too much debt in a low interest rate environment.

Meanwhile, the expansion of the economy, which has grown at a rate of about 9 percent over the past decade, fuels people's expectations of their future income growth. This optimism has encouraged people to purchase big items, such as cars and houses.

Since 1998, when the country began to launch individual consumption credit on a large scale, the individual credit surplus soared to 1,500 billion yuan (US$180.7 billion) last year. The current figure stands at 1,700 billion yuan (US$204.8 billion).

But China remains a developing country. Despite the progress in its per capita gross domestic product, its social security network is yet to provide a comprehensive safety net for its people. Pensions, medical care and education are expected to consume the bulk of their future incomes. Therefore, economic fluctuations may impose a massive burden on those heavily-indebted families. In this sense, policy-makers have, by increasing interest rates, at least admitted the possibility of a debilitating crunch - and acted accordingly. The China Banking Regulatory Commission, the banking watchdog, also tightened its purse strings recently. It ordered that people's monthly bank loan repayments should be below 50 percent of their monthly income. Their overall debt repayments should not exceed 55 percent of their income.

As Liu Jianchang has suggested, the 55 percent cap, even seen from the perspective of Western economies, is still dangerously high. In the short term, risks from high household debt ratios can be offset by the rapidly expanding economy. But in the long run, the high ratio would become unsustainable as economic growth slows down. Once the economic environment changes, the number of loan defaulters may rise and the banks would have to sell that mortgaged real estate at an auction, which will generally lower the market price in the industry and affect the economy in general.

To prevent such a scenario, policies should be devised to gradually lower the financial burden of the homebuyers.

Market-oriented monetary measures can be adopted to gradually force runaway house prices down to a more rational level. Second-hand house transactions should be encouraged to reduce the expenditure of families wanting to buy a house. Moreover, the low-rent programme, which allows low-income earners to rent government-subsidized houses, should also be carried out on a larger scale so everyone is not required to buy their own home.

(China Daily November 16, 2004)