By Yang Hongxu (楊紅旭), Head of Research at Shanghai E-House Real Estate Institute

Translated by Qi Changlong (齊長(zhǎng)龍)

Original article: [Chinese] 

China's Deputy Premier recently said that subsidized housing projects and home purchase restrictions have cooled the country’s over-heated real-estate market, but there should be no loosening of those policies during this critical period.

How should we interpret Li Keqiang’s remarks? Firstly, we should expect the restrictions to remain in force.

In order to understand, we should look at the "Eight New Rules" released in January. In July, the State Council called for measures to bring home prices to a reasonable level. In November, Premier Wen Jiabao said the government couldn’t loosen its restrictions until prices were stable at a reasonable level.

Beijing’s strict implementation of this policy underlines its seriousness about bringing prices under control, but since October, when the housing market soured, there have been differences in tone. First it was "housing prices have fluctuated over the last month,” then it was "achievements have been made".

The logic behind the change of official tone is simple. As the housing market cools, the restrictions should be loosened.

Looking at how policy might now change, we need to consider two main variables: housing prices and the country's economy, where the real estate sector is crucial.

It’s hard to define what the government might mean by “a reasonable level” for house prices.

In order to determine that, we might want to look at the price to income ratio. In the U.S. and E.U., the ratio is 3:1 to 5:1, while in developing countries it’s nearer to 8:1. According to E-house China Real Estate Institute [where this commentator works] , the ratio for China is 7.8:1, but that conceals much higher figures in certain parts of the country, such as eastern first-tier cities, where the ratio is nearer 20:1. Although that figure doesn’t reflect the subsidized housing currently slated for construction, China still has a long way to go before it matches western levels.

It might be more helpful to define how far prices would have to fall in order to reach “a reasonable level” – I have in mind an overall decrease of 10 to 15 percent nationwide, and of 20 to 30 percent in first tier cities and some second tier cities.

It’s worth pointing out that I am referring to the actual difference between the price of an apartment next year and its price before the release of "Eight New Rules;" a difference that won’t be evident in the data from the National Bureau of Statistics.

NBS data tends to hide the severity of price falls. For instance, in 2008, the bureau reported a 1.7 percent year-on-year fall in the average price of newly built houses, and this year it announced a decline of only 1.3 percent for prices in the country’s 70 biggest cities.

Apart from the size of the decrease, we should also worry about the duration of the decline. The decline in Japanese housing prices that began in 1991 continued for a decade. Hong Kong’s fall lasted more than six years from 1997. U.S. home prices took four years to break their doward trend after 2006.

If Chinese home prices continue declining for four years or more, the consequences will be devastating. Fortunately, China’s economic growth, urbanization, demographic structure and housing stock make that impossible.

The last period of concern on China’s real estate market was between October 2008 and February 2009, when housing prices in 70 major cities kept dropping for six months. This phase is likely to last longer, but not more than a year. Housing prices will reach a turning point by the second half of 2012.

In the short-term, the central government will loosen its policy as soon as the price decline meets its target, and local governments will take action even sooner. Moreover, if China’s growth takes a serious knock in 2012, the restrictions may be relaxed even sooner.

In the long run, two variables will determine policy. One is the fulfillment of China's subsidized housing plans, which would provide a discounted alternative for 20 to 30 percent of urban residents. The other is a response to speculation on property prices, for example by introducing broad property taxes and making the market more transparent .