Is the “Chinese miracle” fading to black? The world’s second-largest economy is grappling with a plethora of different challenges. The country is facing below-trend economic growth, a plummeting currency, rising youth unemployment, shrinking manufacturing activity, and a property sector steeped in financial problems.
China is wrestling with “huge structural problems” that threaten the overall economy moving forward, according to Nicholas Lardy, a nonresident senior fellow at the Peterson Institute for International Economics.
“The boom is over,” Mr. Lardy said, noting that Beijing is unlikely to see growth rates of 8 or 9 percent again.
But while some assert that Beijing is spiraling downward to 2 percent expansion amid various problems throughout the country, Mr. Lardy asserts that he doesn’t see this in the data that he’s watching.
“I do think that their growth over the next few years is likely to be significantly higher,” he said during an online Center for Strategic and International Studies (CSIS) event. “I certainly think there are a lot of structural problems. There are a number of threats. But I don’t think they’re going south here.”
Despite abandoning most of the pandemic-era Zero-COVID public health restrictions and reopening the economy, economists’ expectations of a substantial boom never materialized. Consumer demand has been anemic, resulting in a deflationary climate in July. Exports have cratered amid below-trend demand from key trading partners that are facing stubbornly high inflation and slowing growth. The effects of the collapse in the real estate market, which accounts for approximately two-thirds of Chinese household wealth, are spilling into the broader economy.
“We now expect q/q growth of just 3.0% annualised over the rest of the year,” he wrote. “This rests on the assumption that policymakers will eventually intervene more forcefully. But even then, any economic reacceleration is likely to be modest given the structural decline in trend growth.”
China’s Debt Mountain
The debt-laden Chinese property titans Country Garden and Evergrande Group have captured all the media attention, but governments are also dealing with this reality of abundant red ink. And Jude Blanchette, Freeman Chair in China Studies, said at the CSIS event that these debt issues establish a “ceiling for growth.”Federal debt has skyrocketed since 2011 as officials have tried to prevent complete economic destruction during various economic events, including the 2008–09 global financial crisis and the 2015 property sector decline. It’s estimated that the national debt is north of $14 trillion, up by 36 percent from 2022, and represents about 250 percent of GDP. This is a higher ratio than the United States’ but lower than Japan’s.
The chief concern among economists is that this trend could result in a financial crisis or a prolonged economic slump comparable to Japan’s Lost Decade of the 1990s.
But it’s not only the central government that’s observing mountainous debt levels. Local governments—provincial and municipal—are also seeing immense debt volumes, totaling a projected $12.8 trillion in 2022. Leaders are also struggling to keep up with growing debt-servicing costs.
For example, Guizhou, a southwestern Chinese province, is one of the most indebted governments in the country, reporting nearly $166 billion in debt at the end of last year. The debt-to-GDP ratio is 62 percent.
Hegang, a Chinese city bordering Russia, has maintained debt totals that are more than double its fiscal income. Officials have responded to these fiscal holes by implementing more pecuniary restraints.
Experts note that local government financing vehicles (LGFVs) have contributed to these issues. LGFVs have functioned as funding mechanisms to support infrastructure projects. In 2020, for instance, Guangzhou and Shanghai approved $25 billion and $38 billion for infrastructure projects, respectively. Years later, fresh data show that a record number of LGFVs didn’t make payments on short-term debt in July, totaling roughly $260 million.
“Amid a slowing economy and an ailing property market, debt-laden municipalities now pose a potential risk to China’s economic growth and financial stability,” PIMCO analysts wrote in a research note. “If any LGFVs were to default, it would likely create volatility in China’s financial markets, widen credit spreads, cause rates to decline due to a flight-to-quality from corporate to government bonds, and even weaken the yuan.”
But any negative effects would be short-lived, they noted.
The central government instituted reforms last month allowing local governments to replace $140 billion in LGFV debt with local bonds. Chinese leaders have promised to use a “basket of measures” to fend off local debt vulnerabilities. This could include the central government issuing bonds to bail out municipalities despite that officials told local governments earlier this year that there would be no bailouts.
Implications
As the experts debate whether China will experience a prolonged slowdown or a crash, there has also been the question of how Beijing will respond. Will officials support more market-oriented reform or double down on state control? And what would this mean for the global economy, considering that China accounts for roughly a third of worldwide growth?Mr. Lardy said he thinks the Chinese slowdown could influence certain countries closely tied to China.
“It’s going to have a bigger effect on Germany than the [United States],” he said. “But if you’re looking globally, I think there’s a tendency to overstate the importance of China.”
