The Big Picture:When to tighten money?

Easy credit and falling interest rates are the most significant factors affectingproperty prices in China, in our view. Yield comparison suggests that bond priceshave become more expensive since 2014 compared with housing, attesting to theimpact of the falling risk-free rate on asset prices.

Under current accommodative policies, the housing market recovery is likely tospread to lower-tier cities. Demand and supply may become more imbalanced in tier-1 and tier-2 cities, supporting home prices. Historically, city specific purchaserestrictions tended to delay purchases, only to see a large rebound later on.

Meanwhile, the following arguments favor monetary tightening: (1) growth isimproving and fiscal support has been rising, warranting a shift towards tightermonetary policy to address asset prices and inflation. Infrastructure spending hascontributed over 1ppt to GDP growth this year, 20bp higher than in 2015. Fiscalexpansion is likely to continue; (2) Chinese long-term rates are now more affected byglobal rates than in the past. Tighter monetary policies would be necessary to counterthe effect; and (3) the compressed yield spread is signaling underpriced credit risks.

Tighter policies would speed the exit of marginal companies. We believe a shifttowards tighter policies is likely next year.