What went wrong with the Chinese economy

Hong Kong
CNN
–

China has long been the engine of global growth.

But in recent weeks, the country’s economic slowdown has alarmed international leaders and investors who can no longer count on it as a bulwark against vulnerability elsewhere. In fact, for the first time in decades, the world’s second economy is the same problem.

Hang Seng in Hong Kong

(HSI) The index slid into a bear market on Friday, after falling more than 20% from its recent peak in January. Last week, the Chinese yuan fell to a 16-year low, prompting the central bank to mount the biggest defense of the currency ever by setting a much higher price for the dollar than the estimated market value.

The problem is that, after a rapid surge in activity earlier this year in the wake of the lifting of coronavirus lockdowns, growth is faltering. Consumer prices are falling, the real estate crisis is deepening, and exports are stagnating. Youth unemployment has gotten so bad that the government has stopped publishing data.

Adding insult to injury, a major homebuilder and a prominent investment firm have defaulted on payments to their investors in recent weeks, raising fears that the continued deterioration of the housing market could pose growing risks to financial stability.

The lack of firm measures to stimulate domestic demand and fears of contagion led to a new round of growth cuts, with many major investment banks lowering their forecasts for economic growth in China to less than 5%.

“We are underestimating China’s real GDP growth forecast… as the real estate contraction deepens, external demand weakens further and policy support is less than expected,” UBS analysts wrote in a research note Monday.

Researchers at Nomura, Morgan Stanley and Barclays had previously scaled back their expectations.

This means that China could largely miss its official growth target of “around 5.5%,” which would be an embarrassment to the Chinese leadership under President Xi Jinping.

It is a far cry from the global financial meltdown of 2008, when China launched the world’s largest stimulus package and was the first major economy to emerge from the crisis. It is also a reflection of the early days of the pandemic, when China was the only developed major economy avoiding recession. So what went wrong?

China’s economy has been in the doldrums since April, when the momentum from a strong start to the year faded. But concerns escalated this month after defaults by Country Garden, once the country’s largest developer by property sales, and Zhongrong Trust, a major trust.

Reports that Country Garden had lost interest payments on US dollar bonds spooked investors and revived memories of Evergrande, whose default in 2021 signaled the start of the real estate crisis.

And while Evergrande is still undergoing debt restructuring, the problems at Country Garden have raised new concerns about the Chinese economy.

Beijing has launched a set of supportive measures to revive the real estate market. But even the most powerful players are now teetering on the brink of default, highlighting the challenges Beijing faces in containing the crisis.

Meanwhile, debt defaults of real estate developers appear to have spilled over into the country’s $2.9 trillion investment trust industry.

Zhongrong Trust, which has managed $87 billion in funds for corporate clients and the ultra-wealthy, has failed to pay back a series of investment products for at least four companies, worth about $19 million, according to company data earlier this month.

Angry demonstrators even recently protested outside the trust company’s office, demanding compensation for high-yield products, according to videos posted on Chinese social media seen by CNN.

“Further losses in the real estate sector may carry over into broader financial instability,” said Julian Evans-Pritchard, head of China economics at Capital Economics.

He added, “With the increasing flight of domestic funds into government bonds and safe bank deposits, more non-bank financial institutions may face liquidity problems.”

Another major concern is local government debt, which has risen largely due to a sharp drop in land sale proceeds due to the decline in real estate, as well as the continuing impact of the cost of imposing pandemic lockdowns.

Not only do the severe financial pressures seen at domestic levels pose significant risks for Chinese banks, but they also reduce the government’s ability to stimulate growth and expand public services.

Beijing has so far unveiled a steady trickle of measures to boost the economy, including interest rate cuts and other moves to help the real estate market and consumer businesses.

But she refrained from taking any major steps. This is because China has become so heavily indebted, economists and analysts told CNN, that it has not been able to pump up the economy as it did 15 years ago, during the global financial crisis.

At the time, Chinese leaders put forward a four trillion yuan ($586 billion) financial package to reduce the impact of the global financial crisis. But the measures, which focused on government-led infrastructure projects, also led to an unprecedented credit expansion and a massive increase in local government debt, from which the economy is still struggling to recover.

“While there is also a cyclical element to the current downturn that justifies further stimulus, policymakers appear concerned that their traditional policy guideline could lead to a further rise in debt levels that will revert to intensity in the future.” Evans Pritchard.

On Sunday, policymakers in Beijing reaffirmed that one of their top priorities is containing systemic debt risks in local governments.

The People’s Bank of China, the financial regulator and the securities regulator jointly pledged to work together to tackle this challenge, according to a permit by the central bank.

Moreover, China faces some long-term challenges, such as a population crisis, and strained relations with major trading partners such as the United States and Europe.

The country’s total fertility rate, the average number of births per woman will Over its lifetime, it fell to a record low of 1.09 last year from 1.30 just two years ago, according to a recent report by state-owned Jiemian.com, citing a study by a unit of the National Health Commission.

This means that China’s fertility rate is now lower than that of Japan, a country long known for its aging society.

Earlier this year, China released data that showed its population began shrinking last year for the first time in six decades.

“China’s aging demographics present significant challenges to its economic growth potential,” analysts from Moody’s Investors Service said in a research report last week.

A decline in the labor supply and an increase in spending on health and social care could lead to widening fiscal deficits and an increase in the debt burden. A smaller labor force can also erode domestic savings, leading to higher interest rates and lower investment.

“Housing demand will decline over the long term,” they added.

Evans-Pritchard said demographics, along with slowing rural-urban migration and geopolitical rifting, is “structural in nature” and is largely outside the control of policymakers.

“The big picture is that trend growth has declined significantly since the beginning of the pandemic and appears poised for further downturn in the medium term,” he said.