The risk of abrupt changes in government real estate policies remain the biggest threat to the credit worthiness of China's property sector in spite of the strong growth in Chinese home values in recent years.

A study by Xinhua Finance, China's leading financial information provider, indicates that the possibility of swings in Chinese government policy toward the real estate sector pose a bigger threat to the industry than external factors to the stability of China's property market.

China's real estate sector has benefited from the nation's strong economic growth and favorable government policy since the beginning of economic reforms in the Asian giant, causing the real estate sector to enjoy a period of remarkable expansion. But with the slowing of the Chinese economy and the tightening of credit, Xinhua Finance believes that the recent liquidity problems in the industry mark the beginning of a process of unfolding credit risks that have accumulated over time.

Analysts indicates that the progress of China's real estate industry in the on-going depressed environment is
likely to extend over a significant period of time and suggests that investors exercise caution in considering the credit risk implications for debt securities issued by the real estate industry.

The report further points out that the risks confronting the industry arose from an imbalance amongst factors such as markets, development and management expertise, technology, and financing. The continuous growth of the real estate markets without undergoing significant adjustments has led to the accumulation of risks.

Such imbalances are almost inevitable when the market starts from a very low base and expands at such a rapid pace. Compounding the risk is the fact that China has yet to fully transform into a market economy. China's real estate sector has been a captive of struggles between policy-guided and market-based development models since the industry started up. In light of the significant role played by the real estate industry in China's overall economy, governmental change in any policy or level of macro-economic adjustment will impact the real estate sector to some degree.

Tax, banking, business regulation...

Among government policies requiring close monitoring are those related to property development, banking and finance, tax, business regulation, foreign investment, and housing guaranty programs. Adding to the industry's risk are the uncertainties arising from the fact that the formulation and progression of various government policies does not occur in a stable and predictable fashion. As a result, the credit worthiness of the industry and also individual developers cannot be expected to receive particularly high credit ratings.

Regarding the current situation, Dr. Chung-Hsing Chen, vice president and head of ratings and research for Xinhua Finance, argues that "the domestic real estate industry is very fragile and highly fragmented, and
most developers do not have adequate experience dealing with a down-turn in the economic environment. With relative weak financial strength and management expertise, some developers are bound to face critical challenges hen there are major government policy changes or significant market adjustments."

Commenting on the price reductions implemented by some developers in response to the slow down of sales and increased liquidity pressures, Dr. hen stated that although price-cutting to boost sales might help individual developers to a small degree with their cash flow pressures, it ill not significantly improve the liquidity pressures on the industry over he near-term. It is unlikely that pressures which built up over the years in over-heated markets can be relieved within a short period of time. In actuality the liquidity pressures could increase further, since for developers who failed to get additional capital injections, the worst winter is yet to come.

Caesar Ye, Xinhua Finance's chief real estate sector analyst, added that even though the market has recognized that the credit of real estate developers has trended towards the downside, Xinhua Finance will not be adjusting the ratings of real estate developers frequently because credit ratings of individual real estate developers have already taken into account the impact of the economic cycle. However, the conclusions of the
report suggest that even at the peak of the cycle, the real estate industry is not likely to be assigned high ratings. Hence investors should continue to exercise caution in valuing corporate debt securities issued by Chinese real estate developers.