China’s Economy in Grave Danger as Growth Engines Stall, Options Dwindle

After decades of growth, China’s economy and ruling regime face a reckoning.

News Analysis

The world’s second-largest economy is in a world of trouble.

Significant perils are facing China’s economy—the engine of China’s past economic growth has stalled, while today’s unique economic circumstances limit Beijing policymakers’ options.

According to official numbers, China has seen mid-to-high single-digit gross domestic product (GDP) growth consistently over the past 20 years. While most experts today believe that those figures have been inflated, its historical growth was still sizable and was predicated on two main drivers.

Its economic rise has been dependent on 1) real estate and infrastructure, and 2) manufacturing. The latter also relies on exports and foreign demand for Chinese goods. And both have been buoyed by more than a decade of inflows in foreign capital investments.

A third factor, domestic consumption and services, is one that the Chinese Communist Party (CCP) has been pushing for. It’s a smaller part of the nation’s economic growth, relative to other countries. The regime understood that building, constructing, and even manufacturing would eventually all dry up and that its domestic engine would need to be strong enough to carry the economy.

That day has now come, but the domestic consumption economy has also seized up, putting the Chinese economy—and its ruling regime—in jeopardy.

Real Estate Woes

Real estate, by some measures, makes up more than a quarter of China’s economy. Aside from its importance as an economic engine, it also makes up a significant portion of Chinese people’s wealth (the other being the stock market, which has also been tanking). This is especially true for the middle class, which makes up a significant portion of its urban population.

A lot of ink has been used in documenting China’s real estate market slowdown. There’s too much supply, causing many apartments to sit empty. Developers such as Evergrande have collapsed, and previously financially sound developers such as Country Garden are now missing bond payments as well. These developers are all generally funded by U.S. dollar-denominated debt.

Economic growth predicated on real estate requires property values to go up, and developers gorging on high-interest debt need more sales to free up working capital to keep the cycle running.

Beijing has been worried about excesses in the real estate market—both the pace of price increases and higher debt burden—and regulators have engaged in periods of forced contraction and stimulus to manage the market.

But the bottom has fallen out of the real estate market, caused by lower transaction levels on the basis of declining liquidity and declining household wealth. Today, Beijing has less of an appetite to stimulate the property market, given the many fires it must fight on other fronts.

Official Chinese government data are more sanguine, but data from real estate agents and other private data providers paint a dire picture.

A Bloomberg report citing these private data shows that existing home prices have fallen by more than 15 percent in some of the best neighborhoods in tier-one cities such as Shanghai and Shenzhen. A similar trend is playing out in tier-two and tier-three cities.

The result is that developers are losing money, defaulting on their debt, and hurting both foreign investors and domestic Chinese investors who are holding their bonds and stocks. Even state-owned developers are warning that widespread losses are forthcoming.

And this causes consumers to shy away from purchasing apartments from developers that could run out of cash and conceivably not finish building the apartments they set out to construct, creating a downward spiral of lower real estate volumes and lower real estate prices.

Infrastructure and Local Government Debt

A related means to juice economic growth in the past few decades has been infrastructure development.

This is an easy way for Beijing to directly spur the economy. Years of central bank stimulus encouraged waves of infrastructure development—roads, airports, bridges, and power infrastructure—in cities across China. This checked multiple boxes at once: It provided jobs, grew the economy both locally and nationally, and kept the stream of kickbacks flowing to local CCP officials.

Local governments took out huge loans to pay for these expensive and at times wasteful infrastructure projects. Many of these projects were never meant to be profitable, as there was never enough demand for the services.