China's economic woes keep getting worse. Here's why

An individual is positioned close to a housing construction location belonging to Chinese company Country Garden in Beijing on August 11. Country Garden is encountering significant monetary difficulties. Tingshu Wang/Reuters concealment caption.

An individual is seated close to a housing development under construction by Chinese company Country Garden in Beijing on August 11. Country Garden is encountering significant economic difficulties.

Following three years of stringent lockdown measures aimed at preventing the spread of COVID-19, experts had anticipated a rapid resurgence in China's economy in the current year. However, recent data indicates a different trend. The growth rate of retail sales, industrial output, and investments recorded in July fell short of expectations. Furthermore, a decrease in overall demand has resulted in deflationary strain on the economy, which happens to be the second largest worldwide.

Tao Wang holds the position of managing director and chief economist for the Chinese market at UBS in Hong Kong. Tao Wang's photo can be seen above.

To what extent should the United States worry about the state of the Chinese economy? To what degree have the actions of Beijing affected issues in sectors like real estate? China's policymakers were previously commended for their practicality, but can this practical approach persist given the existing political environment in Beijing?

NPR interviewed Tao Wang, the writer of the book titled Making Sense of China's Economy. Wang has previously worked as an economist at the International Monetary Fund and currently holds the position of managing director and chief China economist at UBS in Hong Kong.

What caused China's economy to veer off track in 2023? Should we be alarmed about the direction it is heading in?

It is commonly believed that China's economy will regain its strength this year after three years of implementing strict measures to combat COVID-19. Our expectation for this recovery is based on the assumption that consumption will increase once economic activities return to normal and the job market improves, coupled with a stabilization of the property market. During the first quarter, the economy showed signs of recovery as we anticipated, and in some areas such as property and exports, it even exceeded our expectations. However, as we entered the second quarter, the property market experienced a setback, with a significant decline in housing sales and construction starts. Additionally, local governments faced financial difficulties and consequently reduced their spending, which further hindered economic growth. These circumstances led to destocking in the industrial sector and a slowdown in the recovery of consumption during the second quarter. As a result, the overall economic growth suffered a decline in the second quarter.

In the late July meeting of the Politburo, China's top leadership acknowledged the challenges faced by the economy and made a commitment to implementing more supportive measures in order to stabilize it. We anticipate that fiscal policy will become more lenient, with increased credit assistance for infrastructure investments and a slight relaxation of property policies. Our central prediction is that the economy will experience a recovery in the third and fourth quarters, resulting in a quarter-on-quarter growth rate of 4-4.5%. This would lead to an annual GDP growth of approximately 5% for this year, which aligns with the government's target for 2023. In contrast, the growth rate for 2022 was a mere 3%. However, if the property sector fails to stabilize, either due to limited easing of property policies or the inadequacy of measures implemented, the economy may not regain momentum in the second half of the year and fall significantly short of the 5% target. In such a scenario, a prolonged and severe downturn in the property market would continue to negatively impact the income and confidence levels of both businesses and households, as well as contribute to price depreciation.

Tao Wang's publication, Comprehending China's Economy, presents a thorough understanding of China's economic landscape.

Could the government's stricter regulations and efforts to reduce debt in the real estate industry in the past few years have contributed to the decline in growth?

The government's efforts to control property ownership in 2020-2021 certainly played a significant role in the ongoing decline in property values. However, there were also other factors that contributed to this decline, such as changes in long-term demand and supply for real estate, as well as the impact of the pandemic and related policies. A few years ago, there was a sudden increase in regulations for internet platforms, fintech companies, and after-school tutoring services, which caused significant disruptions in these sectors. Although the government has now indicated a willingness to ease regulations and support the private sector and internet companies, it may take time and concrete actions to restore confidence among businesses. The lack of confidence among businesses is likely one reason for the decline in private investment following the COVID-19 pandemic, although falling profits and orders are also contributing factors.

The state-controlled media has subtly suggested in recent weeks that there might be additional assistance provided to the real estate market. Could this potentially have a significant impact?

I believe that the current decline in property values can be attributed to various factors, such as changes in underlying economic conditions, previous tightening of policies, and the impact of the pandemic. The Chinese government acknowledged the need for a shift in property policy towards the end of 2022, as they realized that the biggest threat posed by the property market was not rising prices and excessive borrowing, but rather a significant downturn that could negatively affect the economy and financial system. Despite some limited efforts to reduce restrictions, the declining trend in property-related activities has not been halted. However, there is hope that the recent supportive policy signal from the July Politburo meeting will lead to additional measures by local governments and various ministries to stabilize property sales and provide more credit to prevent larger-scale defaults by developers.

With the absence of extensive measures aimed at lowering property prices, it is uncertain whether these actions will effectively stabilize the property market in the near future. What is evident, however, is that the underlying factors influencing property values have shifted. China's population is anticipated to have reached its maximum point, the process of urbanization is slowing down, and there is already a high rate of home ownership. Consequently, the demand for property and construction activity will persistently fall below the peak levels observed in 2020-2021, even following a recovery from the current downturn.

The topic of debt has been extensively discussed for numerous years. What is the current severity of this problem?

China currently has a debt-to-GDP ratio of approximately 300%, making it the highest among all developing nations and even surpassing most advanced economies. Although the central government debt in China is relatively low, accounting for just over 20% of the GDP, local governments have a much higher debt level, estimated to be more than 70% of the GDP. Furthermore, a significant number of local governments lack sufficient financial resources to cover the interest on their debt. Additionally, the corporate sector, particularly property developers, is now encountering significant difficulties in meeting their debt obligations due to the ongoing property market decline.

Even though the debt level in China is high and continues to increase, we believe that the likelihood of a "typical" debt crisis or financial crisis, where extensive defaults lead to bank collapses, a severe shortage of available credit, and/or a significant decline in the exchange rate, is comparatively low.

A key factor is that the Chinese government possesses significant resources that can be utilized to help repay debt. Additionally, it is crucial to note that a debt crisis primarily involves a scarcity of funds, and in the case of China, their high level of domestic savings - controlled by capital restrictions at domestic banks - results in over 95% of their debt being domestic. This debt is financed by stable domestic deposits and is not influenced by the changing opinions of international investors. The government's ownership of the banks and its assurance of deposit safety, along with its track record, diminishes the likelihood of bank runs. The government's control over the banks also enables them to prevent credit withdrawal or any scenario that may lead to a credit crunch. Moreover, the government has the ability to inject capital or liquidity into the banking system and effectively coordinate the restructuring of debt in an organized manner, rather than relying on market-driven deleveraging, which can be chaotic and excessive.

However, it is important to note that the escalating debt level in China poses some concerns. Data indicates that debt has been increasing at a faster rate than overall economic output for an extended duration, with a significant portion being directed towards sectors that do not generate value. In the absence of market regulations to address underperforming or failed investments, inefficient and unproductive ventures will overshadow more viable and lucrative ones. As a result, resources will be misallocated, leading to decreased corporate profitability, diminished investment, and ultimately, hindered long-term growth. Moreover, these wasted resources will eventually transform into unprofitable debts that the financial sector will be burdened with, ultimately impacting savers as well.

In your book, you narrate a tale of how China has overseen its economy since 1978. With the economy now facing a critical juncture once more, which previous experiences should China's officials reflect upon while contemplating their next steps?

China is currently confronting major difficulties in its economy, as both the outside circumstances and China's internal economic foundations have undergone alterations. The leaders of China can gain wisdom from their own previous encounters in successfully steering through similar challenges.

To begin with, it is important to remain practical and flexible, just as they have done previously, by modifying policy objectives and approaches in light of fresh obstacles and altered conditions.

Next, remain receptive and expand your horizons towards the global community - global commerce, overseas investments, interchange of individuals and concepts, top-notch international norms and methodologies have immensely contributed to China's progress and continue to hold significance.

In addition, China must persevere with crucial changes and uphold its focus on the market. These reforms have played a vital role in driving China's impressive progress since 1978. As China encounters fresh obstacles, it must now forge ahead with revamping state-owned enterprises, modifying the household registration system, and implementing pension reforms. Moreover, supporting the private sector and revitalizing the fiscal system are also imperative measures to be taken.