IMF warns on real estate bubble

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The International Monetary Fund has warned the Philippine government that one of the risks the economy faces is a “domestic asset price bubble”, which could burst, weaken its financial sector, and slow down economic growth. The IMF made this assessment in its “Country Report No. 12/102”, or its staff report for the 2013 Article IV Consultation with the Philippine government.

By “assets”, the IMF staff was referring mainly to shares traded in the stock market and real estate. “The ensuing risk of asset price bubbles and/or too rapid appreciation could compromise growth’s sustainability and dent employment generation,” it warned.


Source: IMF Staff Report 2013

“Reflecting ample liquidity and the low interest-rate environment, asset prices have risen rapidly,” the report explained.

It reported: “The Philippines’ stock exchange index rose 33 percent in 2012 and a further 8 percent during January 2013, with bank share prices jumping 59 percent in 2012. Nominal prices of high﷓end residential properties have also been buoyant, rising 8 percent year﷓on﷓year, with rents increasing more than 15 percent.”

The IMF data showed that the year-on-year increases in Philippine property prices (proxied by Makati prices) starting 2011 have been higher than those for Indonesia and Singapore, but a bit lower than those for Malaysia. (See chart)

The IMF pointed out that banks’ exposure to real estate has rapidly expanded, and their loans to this industry may not be reflected in their reports to the BSP.

It therefore recommended to the Bangko Sentral ng Pilipinas to monitor not only banks’ credits loans for property acquisition and to property developers but also its credits to thrift banks, which in turn use these funds for the industry.

The IMF report disclosed that the inter-agency committee called the Financial Sector Forum—consisting of the BSP, the Securities and Exchange Commission, the Insurance Commission, and the Philippine Deposit Insurance Corp.—have started “to gather information on all sources of real estate finance”, which should be accelerated and widened.

The IMF warned “real estate developers may (have been applying) less-stringent lending standards and more-generous loan terms than required of banks, including (a higher cap than the standard 60 percent loan-to-value) and by offering initial teaser terms.” The IMF staff claimed “some banks may not also be in full compliance with the loan-to-value limits.”

The IMF explained one possible weakness of the real-estate market by pointing out that “about 80 percent of new residential construction (by number of units) is in the low middle price bracket. Of these, about half are reported to be purchased pre construction by overseas foreign workers.” The risk here, the IMF implied, is the “possible non-renewal of OFWs’ short-term employment contracts”, which could make the real-estate projects unviable.

What is worrying, the IMF noted, is that “no institution has oversight responsibility for the housing sector from a macro-financial perspective.” It explained that such responsibility is not that of the Housing and Land Use Regulatory Board, which merely regulates construction standards and licensing real estate projects.

The IMF here was drawing from the experience of the real-estate meltdown in 2008 in the US, caused by real estate mortgages gone wild, which expanded into an untenable bubble, but were hidden because of complex financial instruments until it was too late.

In its Risk Assessment Matrix, the IMF staff outlined how the real-estate bubble could burst and torpedo the country’s long-term economic situation.

First, here are what it called the “Transmission Channels”:

• “Continued inflows into financial assets and real estate.

• Activity in construction and related industries accelerates, while others weaken.

• Financial sector exposure to real estate grows.”

These will lead to the following events:

• “Near-term growth rises strongly.

• Vulnerability of the financial system gradually builds (up).

• Asset price correction through financial accelerator channel weakens growth.”

The IMF explained how a short rapid growth could lead to a long-term stagnation: “Overly rapid credit expansion, coupled with intensified real estate activity and stretched asset prices—possibly driven by a capital inflow surge—could accelerate GDP growth in the near term. However, a subsequent unwinding would likely have large negative macroeconomic effects over the longer run.”

To prevent the property bubble from emerging, the IMF staff recommended the tightening of regulations on banks’ exposure to property especially with regards to the interpretation of the 20 percent limit on their loans to the real estate industry.

The IMF emphasized: “Prudent loan origination standards and existing regulations should be strongly enforced, supported by a comprehensive positive credit registry, conservative debt to income guidelines for retail borrowers, and granting an explicit legal mandate to an appropriate institution for stability aspects related to the real-estate sector.”

An emerging property bubble was one of five risks to the Philippine economy the IMF staff report outlined. The other four are as follows:

• “Default by a highly-leveraged conglomerate” (discussed in this column last Monday);

• “Capital inflow reversal affecting emerging markets, accompanied by a strong unwinding of asset price overvaluation”;

• Weakening economies of the US and Europe, resulting in smaller Philippine exports and remittances from OFWs; and

• Protracted period of slow European (or global growth).