China’s Economic Crisis: What’s Happening and Why?

China’s economy, the world’s second-largest, is undergoing a crisis. The yuan has dropped to its lowest level against the dollar in 16 years, and Hong Kong’s main index, Hang Seng, has fallen by 20%. The current Chinese crisis is being compared to the US mortgage crisis of 2007, which marked the beginning of a global recession. The Chinese property market is facing challenges that threaten both the global and national economies.

In 2019, when the coronavirus epidemic began in Wuhan, the Communist Party decided to implement a strict lockdown across the country. After the pandemic, the property market began to recover rapidly, partly due to cheap loans. By August 2020, investments in this sector had grown by 11% compared to previous months.

The economic growth continued, but at some point, the real estate market became saturated with unsold properties, with supply exceeding demand. This became the primary cause of the current crisis in China. However, property prices, especially in major cities, have not always been affordable for the average Chinese citizen. Over the past 15-20 years, prices, along with GDP, have risen.

Rising Youth Unemployment and Economic Projections

The crisis has led to youth unemployment: 21.3% of young people aged 18-24 have been unable to find jobs, meaning one in five young Chinese are unemployed. Against this backdrop, China’s National Bureau of Statistics stopped publishing monthly unemployment data, citing a revision of its methodology.

Several major investment banks have lowered their economic growth forecasts for China to below 5%. China is entering a deflationary phase, currently at 0.3%. While lower prices are good for consumers, economists warn that prolonged deflation can lead to a long period of stagnation.

When prices fall over an extended period, consumers reduce spending, and companies cut production, leading to layoffs and wage cuts.

“Three Red Lines” to Reduce Debt

The property market accounts for up to 30% of China’s entire economy. A significant feature is that this sector traditionally relies on borrowed capital. For instance, in 2020, the real estate sector accounted for 28.7% of all outstanding loans, amounting to $1.8 trillion. These figures do not include the shadow banking industry. Therefore, to address the situation, in 2020, the People’s Bank and the Ministry of Housing, Urban and Rural Development introduced the so-called “three red lines”:

  • Debt-to-asset ratio should be no less than 70%
  • Debt-to-equity ratio should be no less than 100%
  • Cash to short-term liabilities ratio should be no less than 1

Companies crossing one “line” could only increase their debt by 10% annually. Two violations limited this to 5%, and three breaches resulted in a debt increase ban. These rules aimed to curb the property market’s debt dependency and the rampant land purchases for resale at higher prices. Some firms concealed their debts to bypass these regulations, prompting regulatory crackdowns.

Evergrande Group, a major construction firm, breached all three “red lines”. Fitch downgraded its credit rating multiple times in 2021 due to escalating debt issues. By December 2021, Evergrande defaulted, and despite assurances, it declared bankruptcy on August 17, 2023.

Comparing China’s Crisis to Past Economic Downturns

The current Chinese economic downturn draws parallels to the 2008 global crisis and Japan’s 1990s recession. Many see Evergrande as China’s Lehman Brothers, whose 2008 fall triggered a worldwide financial meltdown. In response to the 2008 crisis, China injected 4 trillion yuan ($586 billion) into the economy, spurring a 9% growth by the latter half of 2009. Yet, this funding largely fueled government infrastructure projects, causing a surge in credit and local government debt.

Japan’s 1990s economic scenario also offers insights. During its late 1980s peak, Japan was the globe’s second-largest economy, known for its export of electronics. But its prosperity also inflated a real estate bubble. The bubble’s burst in 1991 came after the Bank of Japan hiked interest rates to temper rising asset values.

Government’s Response to the Crisis

In July 2023, sales of the top 100 Chinese developers fell by 33% compared to the previous year. Problems also arose for Country Garden, China’s largest developer. Country Garden reported a significant loss for the first half of the year. The company dropped to fifth place in sales volume. Its shares plummeted by 30%. Moody’s downgraded Country Garden’s credit rating to B1, considering the debt a high risk. In August of the same year, Country Garden defaulted on payments, and investors began to suspect the company was preparing for debt restructuring.

In July, the People’s Bank of China announced it would give developers an additional 12 months to repay loans due this year. However, the Chinese government has not yet announced a specific plan to address the crisis. Premier Li Qian promised to adjust and optimize policies to ensure the healthy and stable development of the real estate market. Cities should implement measures tailored to their needs, he added, without going into details. So far, the response from local authorities has been to stimulate local real estate markets in some major cities, including Beijing.

In 2022, the government announced a 16-point plan, key points of which included:

  • Allowing banks to provide developers with loans that have upcoming repayment deadlines.
  • Supporting property sales by reducing down payment sizes and mortgage rates.
  • Encouraging other financing channels, such as bond issuance.

The plan has not worked so far: the crisis continues and is intensifying.

Other Causes of the Crisis

Besides the property market, several other reasons are destabilizing the Chinese economy:

  • Conflict with Western countries and the trade war with the US deter potential investors and partners.
  • The European crisis means less money for importing Chinese goods.
  • Chinese citizens are saving money or repaying debts; incomes, domestic tourism, and property sales have declined.
  • Over the past decade, Chinese authorities have not implemented significant economic reforms.
  • Strengthening of Xi Jinping’s authoritarian rule and the increasing role of the state in the economy.
  • Demographic crisis. China’s birth rate is lower than Japan’s, and in 2021, the Communist Party allowed families to have a third child. In 2023, for the first time in 60 years, the Chinese population decreased.

Final Analysis

China, an integral cog in the global financial system, is contending with a multifaceted economic turbulence. The confluence of an overextended property sector, geopolitical frictions, and internal fiscal recalibrations have precipitated this downturn. As market analysts and stakeholders monitor China’s strategic responses, there’s an acute recognition of the potential reverberations this could trigger in the international financial markets.