The last Economic news from China They have given me the same feeling of helplessness and low spirits that came over me when the Japanese housing bubble crashed in 1991-1992. Will this feeling of déjà vu continue with China apparently heading down the same path of deflation and stagnation that Japan embarked on three decades ago?
Earlier this month, Evergrande –the huge Chinese property developer that defaulted on its debt in 2021– filed for Chapter 15 bankruptcy protection in the United States in hopes of restructuring its dollar-denominated debts. And now property developer Country Garden has defaulted on $22.5 million in bonds sold abroad and has suspended trading on 11 domestic bonds, raising the possibility of default.
These are not isolated incidents. China’s real estate sector – long a major driver of GDP growth – is reeling under the weight of falling prices, a huge and growing inventory of unsold homes and office buildings and heavily indebted developers. The collapse of the housing bubble seems more likely every day.
The implications for Chinese growth could be dire. Japan’s annual GDP growth was between 4 and 5 percent from the mid-1970s to the 1980s. Behind the bursting of the real estate bubble, that rate sank oscillating between 0 and 2 percent. And to this day, the Japanese economy has not managed to recover the dynamism before the bursting of the bubble.
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multiple shadows
China is already experiencing a sharp growth slowdown. Although it is perfectly normal for a fast-growing emerging market economy to slow as per capita income rises, the magnitude of China’s slowdown in 2022 and 2023 is remarkable. In the second quarter of this year, quarterly GDP grew just 0.8 percent, down from 2.2 percent in the first quarter.
To be sure, growth in the second quarter amounted to 6.3 percent year-on-year, and the government’s annual growth target of 5 percent can still be achieved. However, China’s economic outlook appears to be clouding rapidly. Falling inflation – the consumer price index fell 0.3 percent on-year last month – further darkens the outlook, pointing to possible deflation.
In the second quarter of this year, quarterly GDP grew just 0.8 percent, up from 2.2 percent in the first quarter.
While China’s difficulties can be partly blamed on its delay in abandoning the ‘zero covid’ policy, the slowdown in investment has played an important role. Foreign portfolio investors are withdrawing from Chinese capital marketsand inward foreign direct investment is declining rapidly.
This is partly due to the decoupling between the United States and China. But it is also a reaction to China’s anti-espionage law, under which foreign companies have been prosecuted for activities that are normal elsewhere in the world. Under that law, for example, a Japanese employee of the drug maker Astellas was detained in March and has yet to be released. Not surprisingly, foreign companies are finding it increasingly difficult to recruit employees willing to work in China.
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A handling that does not help
The manipulation and confusion of data by the Chinese authorities offers even more reasons for pessimism. China’s recent announcement that it would stop disclosing youth unemployment figures suggests that the level of unemployment among Chinese youth is truly dire. Given that even official data shows that China’s population began to decline last year, rising unemployment (and underemployment) can only mean one thing: the economy as a whole is rapidly weakening.
China’s demographic decline is also a cause for concern. As Japan can attest, the shrinking working-age population creates strong social and fiscal pressures, including rising pension costs and labor shortages in labour-intensive sectors, such as medical assistance and long-term care. After decades of fertility control policies, China will face a much faster demographic transition than Japan. And while it has expanded social security protection in recent years, it must do much more to meet the demographic challenge before it.
China’s recent announcement that it would stop disclosing youth unemployment figures suggests that the level of unemployment among Chinese youth
it’s really terrible
Two factors unique to China will affect the development of any economic crisis. First, since a large part of the real estate investment It is carried out through the so-called local government financing vehicles, known as LGFV (for its acronym in English), the performance of the sector has a direct impact on public balance sheets. At the end of last year, LGFV debt stood at $7.8 trillion, or 42 percent of GDP.
Therefore, if a real estate bubble bursts, local governments will suffer serious debt problems, and could even default, which could be a severe blow to national and international investors. To help mitigate risks, the central government has authorized local governments to issue their own bonds, whose proceeds can be used to repay LGFV debts. But while this would improve balance sheet transparency, it is ultimately nothing more than substituting one form of debt for another.
The second factor unique to China is that its four largest banks are state-owned, so the central bank and the government can always intervene to provide the necessary capital and avoid a banking crisis. Repeated injections of capital could be considered a sign of ‘moral hazard’. But only 20 percent of non-performing loans in China are the result of failures in the risk management by the banks; the remainder are government-directed loans or loans to troubled state-owned enterprises. So ultimately any bailout is nothing more than a case of the government taking responsibility for the loans it directed.
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If the housing bubble bursts, China’s banks and government must avoid the mistakes Japan made three decades ago. To begin with, it is essential that the information on delinquency is complete and timely. Chinese banks must not succumb to the temptation of evergreening and make new loans to insolvent ‘zombie’ borrowers to make them appear healthy. And when capital injections are needed, they must be done quickly.
In the same way, the Chinese government should take measures to end the evergreening of state-owned and real-estate companies, and ensure that banks and LGFVs pursue debt restructuring, supported by capital injections if necessary. Local governments should also be allowed to raise taxes so they can use the extra revenue to pay off their debts.
If China does not address the risks that are accumulating in its economy, a period of Japanese-style stagnation and deflation will be inevitable. And this time the whole world will suffer.
takatoshi ito
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TOKYO
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