[Trapped in the Chinese Economy]④The Debt Trap...Real Estate Hindering Growth

China's real gross domestic product (GDP) growth rate for the second quarter of this year came in at 6.3%, falling short of market expectations, causing hopes for a strong rebound in the Chinese economy to rapidly fade. In particular, the prolonged slump in the real estate market, which has supported the Chinese economy until now, continues without finding a solution, acting as the biggest obstacle to economic growth. Some warn that the decline and sluggishness in China's housing prices could deliver a long-term shock to the Chinese economy, and that China might follow in the footsteps of Japan, which suffered a prolonged "balance sheet recession" (an economic downturn caused by increasing debt and falling asset prices, leading households and companies to focus on debt repayment) after the bursting of its stock and real estate bubbles in the past.

The global investors' attention was focused on the Politburo meeting of the Chinese Communist Party held on the 24th of last month. In this meeting, Chinese authorities expressed intentions to strengthen policy support to boost consumption and the real estate market, maintain a selective support stance, and continue the transition to qualitative growth, but these were deemed insufficient to meet market expectations. Notably, the phrase "houses are for living in, not for speculation," which had been included in statements since 2019, was omitted. This has led to analyses suggesting that since the core of China's economic sluggishness lies in real estate, the authorities might be stepping back from strict real estate market regulations. However, the prevailing view is that it is premature to interpret this as a shift in government policy direction.

China Faces a Dilemma Over the Real Estate Market

Experts see the Chinese authorities caught in a deep dilemma regarding the real estate market. While China could implement various measures led by the government, such as interest rate cuts to stimulate private investment and the real estate sector, it is currently difficult to achieve effective results. Moreover, such measures conflict with the policy stance pursued by the Xi Jinping administration. Since August 2021, the Xi administration has advocated the "common prosperity" theory, strongly maintaining that housing should not be a target for speculation and has been gradually promoting deleveraging (reducing and repaying debt). The focus has been on preventing financial risks and the need for long-term structural adjustment. Additionally, plans to formally introduce property tax and capital gains tax have dampened the enthusiasm of multi-homeowners to purchase real estate, and the real estate market has struggled since the second half of 2021. According to major institutions, despite expanded policy responses by the authorities, China's real estate investment is expected to decline by about 5.0 to 7.5% this year. The prevailing view is that the Chinese real estate market will find it difficult to show signs of recovery in the near term.

Jae-Hyun Han, Senior Resident Representative of the Bank of Korea in Shanghai, said, "As shown by the -7.9% growth rate in real estate development investment and the -5.3% growth rate in real estate sales in the first half of this year, the Chinese real estate market remains in a prolonged slump." He added, "Although the Chinese government has recently implemented real estate stimulus policies such as raising the loan-to-value (LTV) ratio for first-time homebuyers and lowering loan interest rates, unless the fundamental causes of the slump are resolved, the current stagnation is expected to continue for the time being."

Jin-Soo Kim, Senior Research Fellow at the Korea Institute of Finance, explained, "The rapid increase in non-financial corporate debt has been identified as a significant risk factor for China's economy and financial system. The Chinese government believes that the core of the problem with the surge in non-financial corporate debt, which has reached about 160% of GDP, lies in the rapid increase in debt among real estate companies." According to the National Bureau of Statistics, while the debt-to-equity ratio of China's industrial enterprises remained stable at around 130% from 2012 to 2020, the real estate sector's debt ratio surged from 274% in 2012 to 403% in 2017.

The Real Estate Sector Leads the Increase in Chinese Corporate Debt

In terms of total amount, the debt of real estate companies increased by 63.5 trillion yuan, from 26.5 trillion yuan in 2012 to 91 trillion yuan, leading the growth in corporate debt in China. In response, the Chinese government has implemented policies to reduce the debt ratios across the real estate sector and large real estate companies, which led to crises such as the default risk of Evergrande, China's largest real estate developer.

Especially since the Evergrande crisis in September 2021, risks have expanded due to increased defaults by real estate developers amid declining profits and worsening financing conditions caused by government regulations. As the real estate market has slumped, profits of real estate developers have sharply decreased. According to China Real Estate Information Corporation (CRIC), the combined revenue of 72 listed Chinese real estate developers in the first half of last year was about 1.9 trillion yuan, down 12.6% year-on-year, while net profits plunged 62.5% to 67 billion yuan.

The rapidly increasing debt of Chinese local governments is also a ticking time bomb. The debt scale of local governments stands at about 40 trillion yuan, approximately 32% of GDP, which is 10 percentage points higher than in 2019 before the COVID-19 pandemic. Including the debt of Local Government Financing Vehicles (LGFVs), which serve as funding channels for local government infrastructure investments, the debt reaches about 85% of GDP, significantly exceeding the European Union's guideline of 60%. The Bank of Korea stated, "Due to the slump in real estate, revenues from land-use rights sales, which account for roughly 40% of local government tax revenues, have decreased, further worsening local governments' fiscal capacity. Additionally, about 15 trillion yuan worth of corporate bonds issued by LGFVs during the COVID period are maturing, raising concerns about local fiscal soundness."

The problem is that the shock from the sluggish real estate market spreads through the real economy channels such as construction investment and upstream and downstream industries, as well as financial market channels like bonds and stock markets. According to the Bank of Korea, given that real estate accounts for about 60% of household assets in China, a decline in real estate prices is likely to reduce private consumption through wealth effects. Furthermore, the deterioration of local government finances, where real estate-related revenues such as land-use rights sales account for about 33%, could lead to a contraction in infrastructure investment.

Lee Eun-Seok, head of the China Economic Team at the Bank of Korea, diagnosed, "The real estate-related sector accounts for about 25% of China's GDP, and the deepening slump in the real estate market is exerting downward pressure on economic growth. Liquidity risks have accumulated within the financial market, centered on real estate developers." He added, "Although there are signals that Chinese authorities, who have regulated the real estate market, might shift toward promoting it, the response is likely to remain passive. Given that China has been pursuing deleveraging, it is not easy to reverse this trend, and with a large housing inventory, increasing new supply is difficult, so the real estate market slump is expected to continue for the time being." He also noted that since the fiscal soundness of local governments has not been resolved, introducing stimulus measures could further worsen local governments' fiscal capacity, making it unlikely that aggressive stimulus measures through real estate investment will be introduced even if the economy performs worse than expected.

However, Il-Hyung Lee, former senior representative to China at the International Monetary Fund (IMF) and former Monetary Policy Committee member of the Bank of Korea, said, "The Chinese Communist Party's top priority is social stability. If the authorities judge that the simultaneous deterioration of manufacturing, services, and real estate-related sentiment indicators threatens social stability, it cannot be ruled out that they might shift policy direction sooner than expected."

This content was produced with the assistance of AI translation services.