Over the past 45 years, China has undergone a remarkable transformation, evolving from one of the world's poorest and most isolated countries into a key player in the global supply chains. This economic rise was built on a system of financial suppression, which prioritized investments and exports over domestic consumption. However, recent data show a concerning trend. In September 2023, exports, which have been China’s primary growth engine, experienced a 6.2% year-on-year decline, marking the sixth consecutive month of decline since October. This slowdown in exports was accompanied by other warning signs, including issues with consumption, debts, and real estate investments.
A Meltdown Triggered by the Real Estate Sector
In the past few months, China has faced a streak of economic challenges, including a major property crisis and decreased consumer spending on commodities. In October 2023, both the consumer and producer price indexes experienced a decline.
Concerns are growing over Beijing’s ability to maintain control, especially in light of the default on bonds by one of China's largest real estate developers two years ago. Fears were heightened this summer when troubled developer “Evergrande Group” projected a combined loss of 812 billion yuan (US$112 billion) for 2021 and 2022, surpassing the company's total earnings since its establishment in 1996.
Analysts are drawing parallels to the 2008 financial crisis and have expressed worries about the potential for "financial contagion". This includes the bleak possibility of a property crisis in China, causing a full-blown collapse in the Chinese economy, which could lead to a global financial meltdown.
To understand the magnitude of this problem, one needs to examine the historic shift towards private property ownership in China. Back in the mid-20th century, under Mao’s regime, China strictly adhered to a communist ideology, which meant that the state had control over properties and resources. However, as the century neared its end, elements of a more capitalist framework were introduced. One example of this shift was seen in the housing sector reforms of 1998, where individuals who needed a new home had to purchase it privately. This led to a rapid increase in home ownership, fueled by the low cost of borrowing. As a result, there was an unprecedented demand for real estate development and finance. In 1980, only about 20% of the population resided in cities, but by 2021, that figure had risen to 60%. Consequently, millions of houses were constructed.
For decades, a strong housing market in China has helped lift people out of poverty. According to a survey by the People's Bank of China, property accounted for 59% of household assets in early 2020. However, this also created a leaning tower of debt, as property accounted for 75% of household liabilities. The Chinese real estate market is reliant on shadow banks, which are lending institutions outside the traditional banking sector. This reliance has contributed to total corporate, government, and family debt reaching more than 300% of annual economic production.
Due to slower demand for new houses compared to supply, the entire real estate model is now crumbling. This is a major issue in China, where the real estate industry accounts for 20% of the GDP. When considering spending on construction materials like steel and copper, as well as furniture and other related purchases, estimates suggest that the real estate sector’s share of the economy could rise as high as 35%[i]. In comparison, this sector represents only 16% of the US GDP. The oversupply of housing in China is undoubtedly a ticking time bomb for a potential bubble burst.
The Consequence of a “Reckless Expansion”
Demographic growth and urbanization were not the only triggers contributing to the surge in demand on properties in China. The improved per capita income enabled families to invest their direct savings in real estate, which is considered the most lucrative investment option in the country. In order to respond to this growing demand, property developers needed substantial financial leverage to fill the market gap. Evergrande and Country Garden, China's two leading property developers, borrowed increasingly large sums to construct more and more homes. As a result, their liabilities have reached 340 billion dollars and 200 billion dollars, respectively. This borrowing trend has been emulated by many other developers across the country.
China's Central Bank has called this borrowing frenzy a “reckless expansion”, indicating that the government did not endorse such practices. However, it is indisputable that these companies are now struggling to service their debts. Country Garden, for instance, reported a 6.7 billion dollar loss in the first half of this year, with a 44% year-on-year decline in sales in the first six months of 2022. The company’s shares have plummeted by approximately 70% this year, while its bonds are trading at about 5 cents on the dollar (as per Thomas Hale et al in a Financial Times article). This performance raised concerns about the company’s ability to meet its debt repayments, echoing the scenario of Evergrande’s default two years ago.
These firms are not solely focused on property; they have diversified activities in their portfolio. Evergrande, for example, owns an electric car firm, and one of China's biggest football clubs, Guangzhou ft. These firms represent the tip of an iceberg. The government-imposed restrictions on developers, aimed at containing the Evergrande crisis, have further strained the entire sector. As developers found it harder to access funds, the rate of construction slowed down. Some projects didn't start, some didn't get finished, and the “Business Insider” reported in 2020 that China has at least 65 million empty homes, enough to house the population of France!
According to Bloomberg data, Chinese developers have defaulted on approximately $115 billion of $175 billion in outstanding offshore dollar bonds since 2021, with a larger pool of onshore bank loans also being restructured or rolled over. The escalating debt issues may worsen, given that the era of cheap money is no longer sustainable.
With Covid-19 lockdowns, among other global cascading crises, a slowdown was inevitable. As growth slowed, issues in China's housing sector became apparent. Numerous urban areas remain unoccupied, with some becoming known as “ghost cities”. The vacant buildings can be attributed to a variety of reasons, including the sale of land by local governments to developers in areas where housing demand was insufficient. Another reason is that some of these properties were purchased as investments rather than as primary residences.
The real estate crisis has the potential to incite social unrest, thereby threatening Deng’s approach of “no politics, no problems” that effectively managed the massive population under control for decades. Buyers, who have invested in undelivered properties, have resorted to repeated protests against the defaulting developers. Such protests are rarely tolerated in China.
A Chinese Snowball Effect
China is currently facing major issues with its economy. Not only is it experiencing a slowdown, but youth unemployment has also reached a record high of 21.3% in June. Additionally, a property crisis is adding fuel to the fire, with major developers going bankrupt and housing prices declining due to decreasing purchasing power.
China's economy is a major engine in the global economy, as it is the world's second-largest economy, and responsible for 40% of the global growth. The US credit rating agency, Fitch, expressed concerns about China's slowdown, stating that it is “casting a shadow over global growth prospects." As a result, Fitch has downgraded its forecast for the global economy in 2024.
China’s significant trade surplus means that any changes in growth rate will have a greater impact on the country compared to the rest of the world, according to some analysts. Nevertheless, if China’s population of 1.4 billion reduces its spending on goods and services, this will result in decreased demand for raw materials and commodities worldwide. In August 2023, China’s imports were nearly 9% lower than the previous year, when it was still under zero-Covid restrictions. Roland Rajah, director of the Indo-Pacific Development Centre at the Lowy Institute in Sydney, states that major exporters such as Australia, Brazil, and several countries in Africa will take the hardest hit by this. To add, Europe, China's largest consumer, is also facing the possibility of a recession, leading to reduced purchases.
Over the last 10 years, China is estimated to have invested more than a trillion dollars in huge infrastructure projects, known as the Belt and Road Initiative. These projects have provided funding and technology to more than 150 countries for the construction of roads, airports, seaports, and bridges. However, the current situation be restrained under the current situation.
Analysts predict that the Chinese crisis will have a significant snowball effect, making it difficult to estimate its full impact at the time. According to Bloomberg, China's housing slump is much worse than official data suggests, and the decline in house prices is causing various ripple effects. Global corporations are expected to experience a deterioration in consumer demand, which is particularly concerning given that the 200 multinationals based in America, Europe, and Japan are making about 13% of their sales from China.
Shifting Dynamics
There are also additional concerns that domestic economic crises could prompt the Chinese government to take more aggressive actions against Taiwan, which could be an attempt to gain better access to Taiwan’s strong economy.
Conversely, a more vulnerable China may seek to repair its strained relations with the US. American trade restrictions have partly contributed to a 25% drop in Chinese exports to the US in the first half of this year. US Commerce Secretary Gina Raimondo recently described China as “uninvestable” for some American firms.
This shift in dynamics was evident during the Xi-Biden Summit in San Francisco in mid-November. During the summit, Chinese President Xi stated: “For China and the United States, turning their back on each other is not an option. It is unrealistic for one side to remodel the other, and conflict and confrontation has unbearable consequences for both sides.” If these words are truly meant, they could potentially put an end to the trade war between the two largest economies and halt the trend of de-globalization.
India is also benefiting from China’s economic slowdown. Many companies that are shifting their operations out of China are now turning to India. For example, Apple has increased manufacturing in India. In 2020 to 2021, 95% of iPhones were manufactured in China and only 5% in India. However, the current distribution has shifted to 86% in China and 14% in India. Experts predict that India will experience faster growth than China for a while and will achieve what China has accomplished in a shorter period of time. According to the IMF, India is expected to grow at a rate of 6.3% this year with, its per capita income growing 3.5% faster than China.
Chinese Efforts to Manage the Crisis
In the face of the current crisis, Beijing does not seem to be stepping in yet with a kind of stimulus spending that was seen during similar situations in the past. Back in 2008, during the sub-prime crisis, the government announced a record stimulus package of 586 billion dollars to support the economy.
In 2008, China experienced an annual growth rate of 9.7% following a peak of 14.2% in 2007. However, this year, the projected growth rate is only 5.4%. Despite this, the government’s actions against the ongoing property market crisis since 2020 appear to be ineffective.
China has been implementing policies aimed at catering to the residential sales market and promoting the healthy growth of the real estate industry. These measures included easing limits on the classification of first-home buyers, reducing existing first-home loan rates, and extending tax breaks. According to the Ministry of Finance, taxpayers who buy a new property within one year after selling their previous home in the same city will receive a personal income tax refund on the sale, from January 1, 2024, to December 31, 2025.
American economist Adam Posen, and author of “The End of China's Economic Miracle”, has referred to China's current situation as “a case of economic long COVID.” He adds that China "has not regained its vitality and remains sluggish even now that the acute phase (three years of exceedingly strict and costly zero-COVID lockdown measures) has ended."[ii]
