By: Sanoop Suresh, Research Analyst, GSDN
The phrase “To get rich is glorious” was coined by Deng Xiaoping during his time as the paramount leader of the People’s Republic of China (PRC) to enable a financially prosperous China under communist rule. Deng believed that increasing production was the first step toward reaching common prosperity. Since then, the PRC has played a considerable role in the world economy and emerged as the second-largest economy in 2010. Recent estimates indicate that China accounts for 14.4% of global trade and 18.2% of global GDP. Due to the globalisation of the world, any economic wind that affects one player’s economy will cause a whirlwind in the global economy. Because of how the globe is now interconnected, there are rising concerns about the state of the world’s wealth as the PRC faces another financial crisis. For China, dealing with the economic crisis is nothing new; the country faced similar problems during the 2008–2009 global financial crisis, and the 2015–2016 stock market turmoil was only the latest example. However, the recent changes in the Chinese economy give a skewed view of the future, not just for Beijing but also for the rest of the world.
What is Happening in China?
China’s economic crackdown has been in the making for a while, and the faulted strategy of Covid management and the harsh quarantine measures significantly contributed to its birth. To avert inflation, China refrained from large Covid-era subsidies, which decreased disposable household income due to the concurrent stagnation of wages and property prices. The National Institution for Finance and Development reported that China’s household debt climbed from 61.9% of the national GDP in 2022 to 63.5% in the second quarter of 2023. It is approaching the red line of 65 percent that the International Monetary Fund previously used to indicate financial risk. Recent data suggest that the Chinese economy is also experiencing deflation, which causes great concern among analysts.
Deflation, as opposed to inflation, is an overall drop in the average price of goods and services across the entire economy. The consumer price index decreased 0.3% from a year earlier in July, the National Bureau of Statistics of China reported in August. These statistics signal the slowing pace of economic growth. Although China had a brief surge in economic activity once the stringent pandemic restrictions were lifted, the situation gradually deteriorated into a loss of confidence in the economy, which prompted People to save money rather than invest it in goods. The issue worsens due to a domino effect that spreads throughout the manufacturing sector and eventually into the labor market. China recently stopped publishing data on youth unemployment after finding that the number of unemployed young people aged 16 to 24 in metropolitan areas increased by 21.3% in June compared to the previous month. Reports state that foreign direct investment in China has decreased to 25-year low, and large-scale Chinese share sales have occurred among international investors. However, the ongoing economic collapse in China primarily affected the Chinese real estate market.
Why is China responsible for the downfall of its real estate market?
In the hope of recovering from the 2008 global economic crisis, Beijing borrowed money at the local level and invested in infrastructure projects, which were subsequently reflected in the real estate sector. Since 2016, the Chinese government has pushed the real estate sector through a variety of regulatory initiatives, helping Beijing surpass the United States to become the world’s largest real estate market. Reports say that Chinese households put up to 80% of their money into real estate. According to recent estimates, the real estate sector and other allied industries make up close to 35% of the Chinese economy. However, the once-vibrant industry and the main players facing a debt problem are now feeling the heat of the ongoing economic crisis as a result of the flawed structural arrangements.
Since the COVID pandemic had a negative impact on China’s economy, Beijing made the decision to lower interest rates in order to encourage citizens to borrow more money, which led to a boom in the real estate sector. The industry’s foundation became unstable due to China’s commitment to expansion at any costs, which led developers to rely on debt and loans. Due to the abrupt limits on borrowing by the authority, the “three red lines” in 2020 tied the real estate businesses, leaving many of them without finances. In the last three years, more than 50 Chinese developers defaulted on their loans or failed to make payments, and the major players in the sector are currently travelling the same path.
The 1992-founded Country Garden, a major player in the Chinese real estate market, is currently experiencing the worst crisis in its thirty-year existence and expects a loss of up to US$ 7.6 billion in the first half of the year. The Evergrande group, in a similar vein, has a total debt of about US$ 300 billion. These facts demonstrate the crises’ evenness and breadth, which has an impact on both the general public and the local governments. It is extremely concerning for economists that land sales, which account for 40% of all local government revenue, declined at a time when local governments in China were also faced with an impending financial crisis.
Why might local governments go into default?
Beijing’s 1994 “fiscal decentralization” policy restricted local governments’ borrowing rights and revenue streams, forcing them to discover alternative financing strategies like the Local Government Financing Vehicle (LGFV). These platforms are frequently employed to raise money for infrastructure investments that do not yield immediate returns, which causes the regional economy to rack up hidden debt. The LGFV has since become a significant source of revenue for the local government.
The zero covid policies and the ensuing economic pressures caused a growth in hidden debts, which demand higher interest rates and quicker payback which the local governments cannot meet. The looming crisis, which grew later, was foreshadowed in 2020 when Chinese state-owned firms defaulted on debt worth 71.8 billion Yuan. Without taking into account the reported borrowings, new estimates place China’s local government’s covert loans between 30 trillion to 50 trillion Yuan. The Chinese media outlets indicate that the local governments are having trouble making their payments and are being forced to impose restrictions on wages and fuel subsidies in addition to failing to provide public services. Beijing is making a valiant effort to address the issue by reducing debt, but strangely, rumours indicate that they are once more considering taking on more loans.
Beijing reportedly permitted the provincial governments to issue bonds worth 1 trillion Yuan to cover the unofficial borrowing of local governments. The program effectively shifts the burden to provincial governments by bailing out weaker issuers, such LGFVs. Even if purchasing additional debt to pay off existing borrowings will be futile in the long run, this strategy will allow Beijing time to restructure its economy. However, failing to do so will have catastrophic repercussions that severely hurt the world economy.
Why would the global economy suffer if the Chinese economy collapsed?
In spite of its controversial reputation as an authoritarian nation, China is the world’s largest exporter of products and a significant bilateral trading partner for a number of countries. The world is currently just waking up from an economic slowdown brought on by a number of factors, including inflation, the Russia-Ukraine conflict, and extreme weather events. As a result, a drop in China’s economic activity could seriously disrupt the global demand-supply balance. China consumes a substantial portion of the world market’s energy, raw resources, steel, and food. Those countries who are dependent on China are being forced to look for alternate solutions by the current crisis, although it is difficult to do so.
165 nations owe China US$ 385 billion as part of their “Belt and Road Initiative,” which is further distorting the image because many of these nations are experiencing political and economic upheaval. The current crisis will compel other nations to plunge further into economic and political dangers. On the other hand, Beijing has little choice but to restructure its economy in order to avoid social and political turmoil in China, where the situation is the same.
Does China have a plan to resolve the crisis?
Despite uncertainty regarding its future, China’s economy is still expanding. The Chinese economy reportedly increased by 5.5% in the first half of 2023.The National Australia Bank forecast a 5.2% of economic growth for China in 2023. Beijing is not striving to match the pace of the outside world, but rather that of its own history. Without waiting for others, the Chinese economy grew rapidly for a number of years, but the current financial crisis has made it more difficult to keep up that pace. Dealing with the economic crisis is nothing new for China; the nation had a similar set of issues during the global financial crisis of 2008–2009, and the 2015–2016 stock market upheaval was merely the most recent instance. China was able to stop the crisis in both of these cases by cutting interest rates, encouraging people to borrow money, and boosting economic activity. China is once more seeking to revive the old game plan in an effort to stop the present crisis and build confidence among its people to invest their money in the market. It is difficult to predict whether it will be successful, but the current crisis once again highlights the weak points in the fundamental underpinnings of the Chinese economy. It necessitates a deliberate reworking of the policies to reduce their reliance on debt and look into other avenues for maintaining a strong economy. To accomplish this, China still has a long way to go.