[Insight & Opinion] China’s Real Estate Crisis Calls for Flexible Policy Responses

Increase Exports to Prevent a Hard Landing
Consider Supplementary Budgets if Domestic Demand Remains Weak

Following the bankruptcy of Evergrande Group, China's second-largest real estate company, concerns about a real estate and financial crisis originating from China are growing due to the default risk of Country Garden, the largest real estate developer. However, the likelihood of this situation escalating into a financial crisis is low. Considering that bubble bursts and financial insolvencies occur when demand decreases due to reduced exports or domestic economic downturns, the current U.S. export restrictions on China could reduce Chinese exports and trigger a bubble collapse.

However, the Chinese government, which emphasizes socialism and common prosperity, is expected to manage insolvencies through public fund injections or nationalization of enterprises if housing prices fall to a certain extent. Another factor is that China’s lack of capital market openness limits capital outflows that could spread a financial crisis. Although the possibility of a financial crisis spreading is low, the stagnation in construction and social overhead capital (SOC) sectors, which account for 44% of China’s GDP, combined with U.S. import restrictions on China, could significantly slow China’s growth rate. A slowdown in China’s growth could shock the South Korean economy, which is highly dependent on exports to China, making it urgent for the government to prepare countermeasures.

First, exports must be increased to prevent a hard landing of the economy. The government initially expected a "low in the first half, high in the second half" (上低下高) economic pattern this year. However, if China’s growth slows and exports to China decrease, South Korea may find it difficult to achieve the targeted 1.4% growth rate for this year. Additionally, a decline in exports could widen the trade deficit and worsen the current account balance, raising concerns. In fact, as exports to China have decreased, the trade balance turned negative again from August 1 to 20, and overall exports have been declining for ten consecutive months. Policymakers should diversify export markets and activate export strategy meetings chaired by the president to respond to the decline in exports to China.

Stimulating domestic demand is also necessary. High interest rates have increased interest burdens and living costs, reducing disposable income and making life increasingly difficult for ordinary citizens. If the economic downturn continues, loan delinquency rates will rise, increasing the risk of financial insolvency. If exports do not increase, policymakers need to stimulate domestic demand through supplementary budgets. Although supplementary budgets increase fiscal deficits and worsen fiscal soundness, it is advisable to increase fiscal spending when the benefits of economic stimulus?such as reducing citizens’ hardships and preventing financial insolvency?outweigh the costs.

Measures to counter capital outflows are also needed. Since China has not liberalized capital flows, the direct impact of this crisis on global and domestic financial markets may be limited. However, considering China’s status as a G2 economy, its financial insolvency and economic downturn could dampen investor sentiment, exacerbating turmoil in global financial markets as well as in South Korea’s financial markets.

Moreover, as inflation remains unchecked and labor shortages prevent wage growth from slowing, the U.S. is expected to raise interest rates once more before the end of the year after September. The current 2 percentage point interest rate gap between South Korea and the U.S. may widen further, and if exchange rates rise in the foreign exchange market, concerns about capital outflows will increase. Policymakers, who find it difficult to raise interest rates further due to fears of financial insolvency and economic downturn, must focus on stabilizing the foreign exchange and financial markets to prevent capital outflows.

The South Korean economy faces difficulties both domestically and externally. Domestically, high interest rates and economic downturns are increasing concerns about financial insolvency and hardships for ordinary citizens. Externally, U.S. interest rate hikes and China’s real estate crisis are worsening export conditions and heightening foreign exchange market instability. Policymakers must stabilize the economy by increasing exports and stimulating domestic demand simultaneously. Flexible policy choices are needed to respond to the China real estate crisis.

Kim Jeongsik (Emeritus Professor, Department of Economics, Yonsei University)

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