Official Land Prices: A Signal for Accelerated Monetary Tightening?
March 27, 2007
By Takehiro Sato | Tokyo
Risk that BoJ could take heart from end of land price deflation
Official land prices for 2007, published on March 22, showed the first upturn in the nationwide average in the 16 years since 1991, and commercial land in the major cities rising at a double-digit rate. These results came as a fresh surprise to us as they exceeded our expectations. Since the announcement, investor interest has turned to the question of whether this could be a catalyst for accelerated monetary tightening. Our view is that the pace of monetary tightening will not necessarily accelerate as a result, because official land prices are a lagging indicator by a year or two, and in real time the pace of growth is slowing, while in its own release the MLIT pointed out that much of the boost to the overall average came from sharp land price gains in a limited number of districts in city centres. That the BoJ is tending in favour of synthetic judgements based on its ‘second perspective’ in monetary policy guidelines, even amid the growing consensus that prices will soon turn downwards, is probably in itself one reason why investors remain concerned. We expect the BoJ to remain hesitant about tightening for the rest of 2007, largely because of subdued movements in prices in general. However, if the BoJ Tankan in early April and the January-March GDP data due out in early May deepen the conviction that the economy is firm in general after the sharp bounce in GDP in October-December 2006, we would not necessarily rule out the possibility of a rise in expectations for a rate hike after the Upper House election. At the same time, we need to take a clear look at the current situation. For a start, it appears that the trend in real-time land prices is calmed down, as discussed in more detail below. Moreover, movements in general prices are the overriding point of interest, and here it looks as though the fall in the core CPI inflation rate will move deeper into negative territory heading into the summer. There is also the matter of ensuring consistency between objectives and methods in macroeconomic policy. Is it even appropriate to conduct macroeconomic policy on the basis of land price growth limited to certain areas of city centres, given that in the majority of regions land prices have yet to hit the bottom? Rushing ahead with policy normalisation and focusing on a few extreme examples could result in overkill where the whole picture is concerned, though we do not expect the BoJ to be so biased in its stance. Our real estate analyst is not getting too excited about land prices Our view on the condition of the real estate market is much more sanguine than the media headlines ringing the end to land price deflation. Below we include a comment from our real estate/J-REIT analyst, Tomoyoshi Omuro. “This confirmation of a strong rise in official land prices may well mean that actual prices in the major cities are near the peak, given that the official data are a lagging indicator. Still, office rents should rise (asking rents applied to new rents are increasing at present but existing rents are not yet, overall), and even if land prices in the major cities, which have risen most strongly, soon corrected temporarily, we think it unlikely under the income approach to value that land prices would completely peak out while rents keep rising. If asking rents gradually drive up existing rents when land prices are not rising or falling dramatically, property yields, which have been declining because of the overheating in the property sales market, should also return to equilibrium levels.” In other words, our real estate team takes the view that the cause of growth in land prices is shifting from the falling cap rate to growth in rents, and because real-time land price growth is easing, too, there seems to be little scope for significant further upside in city centre land prices. On the other hand, there also appears to be little risk of downside as existing rents increase. In fact, if rents increase while land price growth comes to a halt, although yields in the real estate market could adjust automatically because of the market mechanism, this could only be to the good of the general health of the real estate market. To put it plainly, what has gone up too much must come down again. If the BoJ shares this view on the current situation, it is unlikely that the latest official land price data will spark concerns of a bubble, or in turn lead directly to a faster pace of monetary tightening. Moreover, the very fact that growth in real-time prices appears to be slowing already suggests that things are going to be different this time around compared with the 1987-88 bubble. In 1988, official land prices rose by more than 20% as nationwide averages for both residential and commercial land, but in 2007 the nationwide average for residential land is up by just 0.1%, and commercial land is also up at a much milder rate of 2.3%, making for land price growth of a very different magnitude. The BoJ does not think there is a bubble now, but does have a stronger impression of land prices than the official figures When it comes to forecasting policy, it is also useful to have a grasp of how the BoJ is reading the official land prices. On this point, it is interesting to note that in the last Outlook Report (October 31, 2006), the BoJ provided an official view with a graphical picture of its official view on the trend in land prices. The exhibit in question listed official land prices as published by the MLIT and by the various prefectures (simple averages), alongside an outline of land prices on a weighted average basis according to the BoJ’s calculations (as of January 1, 2006, and July 1, 2006 respectively). In the notes to its graph, the BoJ said that “official land prices are taken from a sample survey and do not necessarily show changes in the total market value of land”, and commented on the need to look at weighted average land prices (which average out rates of change in official land prices at each survey site against levels for official land prices per square metre at each survey site in the previous year, and equate to the rate of change in the overall value of land prices). Not surprisingly, weighted average land prices show a faster rate of growth than the MLIT’s official land prices, which are on a simple average basis. Without even reading the text of the Outlook Report, we think this exhibit says a lot about the message the BoJ wishes to convey. We also expect this graph to be updated on the basis of the latest data in the next Outlook Report on April 27. We will need to keep an even closer watch on these kinds of signals given off by the regulators, because the ‘second perspective’ that the BoJ is increasingly leaning towards to lend authority to policy changes at a time when prices look likely to start falling gives the regulators a great deal of scope for discretion in arriving at synthetic judgements. Even so, to repeat what we said earlier, we do not think that the BoJ will necessarily become more concerned about a bubble as a result of its synthetic judgement. This is because we think it will be difficult to prove in practice whether in the certain city centre examples that are driving overall growth, the growth in individual cases is unrelated to fundamentals and is therefore inappropriate. Moreover, as long as the trend in land prices does not go beyond such micro issues, we would not expect it to form a cue for macro policy.
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Aggressive Rate Cuts Likely, but Is That Enough?
March 27, 2007
By Chetan Ahya and Tanyee Gupta | Mumbai
Cutting 2007 GDP growth forecasts further Our recent meetings with the corporate sector indicate little scope for a revival in private business spending until elections are out of the way. The government is also unlikely to increase its spending in the current political environment. Indeed, in real terms, government consumption as well as capital spending declined during the quarter ended December 2006. The government’s decision recently to defer the bidding for the mass transit rail system project implies that there is unlikely to be any support from capital spending during 2H07. With the poor investment trend and consequently low job creation, and poor sentiment, we do not expect private consumption to support recovery in growth either. Exports, which have been the bright spot so far, are also likely to decelerate over the next 6-9 months with the moderation in global growth and lagged adverse impact of the recent appreciation in real effective exchange rate. We are cutting our 2007 GDP growth further to 4% from the current 4.3%. Aggressive rate cuts likely The Bank of Thailand (BoT) has maintained a very conservative monetary policy so far. The BoT has chosen to wait for clear signals from the growth and inflation trends before initiating rate cuts. Both these indicators now favor a quick response from monetary policy. Core inflation has already decelerated to 1.3% as of February 2007. Indeed, with oil prices stabilizing around US$60/bbl and domestic macro conditions continuing to weaken, inflation is likely to decelerate further in 2Q07. Indeed, real short-term interest rates in Thailand are now one of the highest in Non-Japan Asia, providing attractive yield, resulting in appreciation pressure on the currency. The BoT has already cut rates by 50bp in Jan-Feb 2007, bringing the policy rate (1-day repurchase rate) down to 4.5%. We believe that the macro trend has now increased the probability of a 50bp cut in policy rate to 4% in the April 11 monetary policy meeting to as high as 75%. We expect the policy rate to be at 3.75% by year-end, compared with our earlier estimate of 4%. Closer to bottom but meaningful recovery needs resolution to political uncertainty If the BoT cuts the policy rate by 50bp in April, market sentiment may improve for a short period. However, we believe that domestic business and consumer confidence is unlikely to revive significantly unless the political conditions are resolved. The popularity of the current government has been affected due to the deteriorating macro condition and relatively slow progress towards handing over power to a democratically elected government. If elections are not held on schedule, people may become restless, making the case of holding back power for the interim government difficult. Although the government has recently confirmed its intentions to hold elections by end of the year, we believe that there are still many challenges to be addressed to ensure successful transition to a democratically elected effective government. Some of the key hurdles to be crossed before a new government can be formed are: First, a decision needs to be taken on the status of the existing political parties: The Constitutional Court is likely to decide whether some of the political parties need to be dissolved. This is likely to be announced by end-April or early May. If the court decides to dissolve these parties, it would mean that the existing infrastructure of the political parties will be dismantled and there would be time lost in re-constituting these parties. Second, decisions are required on court cases against select politicians: There are court cases pending against a few politicians. We believe that the government would like to see a conclusion to these court cases before elections are held. Third, re-drafting the constitution: The interim government also needs to put forward the amended constitution soon. We expect the draft of the new constitution to be ready by next month. By June-July, the Constitution Drafting Assembly will review the draft and propose amendments. These amendments are aimed at increasing checks and balances in the political system for opposition parties in the parliament to be able to voice their opinion freely. By September, the government will seek a national referendum on the amended constitution. If the referendum is approved, that would be the ideal outcome. However, there is a chance that the referendum verdict is negative. In such a case, any former constitution will be adopted within 30 days. This will be followed by elections, after which the new government would be empowered to decide whether to pursue further reforms. Even if everything goes smoothly to hold elections in time, it appears that the most likely government will be a coalition with the Democratic Party and other parties (being formed from the break-up groups of the erstwhile Thai Rak Thai party). In our view, Mr. Somkid, the ex-finance minister in the Thaksin government, could play an active role in bringing together the party/parties formed by ex-TRT members. For sure, the formation of the new government will be a positive outcome, as finally the political uncertainty would be resolved. However, it will still face the challenges of a coalition government, especially in the first few months. Bottom line Growth continues to decelerate sharply. GDP growth in 2007 growth will be lower than 2006. While the monetary policy response is likely to improve preventing further deterioration in growth, we believe that the political uncertainty needs to be resolved for a meaningful recovery in growth. In that context, we believe that the outcome of April/May’s court decision on the status of political parties, amendments to the constitution and later the verdict of the public on the amended constitution should be good indicators of the likely direction in which the political situation is headed.
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