Reuters interviewed more than seventy experts and a number of financial investment institutions in November to predict China's economic growth in 2024. According to the results, most experts and scholars estimated that China's GDP will grow at 5% in 2024. They were also asked to forecast China's economic growth rate in 2025. The average projected growth rate fell to 4.3%, indicating that most of them saw a downward trend of China's economy in 2024 and 2025. These experts concluded that the main reasons darkening China's economic outlook were debt crisis in China's housing market and the extremely high unemployment rate with the youth unemployment rate reaching a high of 40%, said Reuters.
Moody's, one of the three main international credit rating agencies, announced a downgrade of China's sovereign credit rating to negative from Aa1 stable on December 4th. Based on the financial theory of the efficient market hypothesis (EMH), the time when this announcement was made should be the low point that witnessed a sell-off of Chinese sovereign bonds. But the actual development may not follow the pattern.
China's local debt problem has been scrutinized by global investment institutions since 2012. According to the statistics of Taiwan’s Economic Daily News, as of November 2nd, the cumulative issuance scale of China's local bonds reached 8.6 trillion yuan, an increase of 1.2 trillion yuan from 2022 and hitting a new record high.
Chinese financial experts said that China's local government debts would amount to 9 trillion yuan in 2023 when adding the so-called special refinancing bonds, the amount of old debts replaced by new debts. According to the use of funds and repayments, local debts are divided into general debts (simple contract creditor) and special bonds (revenue bonds). By the end of October 2023, a total of 4.3 trillion-yuan local bonds were issued, including more than 650 billion yuan of general bonds and 3.7 trillion-yuan of special bonds.
Debt is a necessary evil for economic operation. China can turn local debts into sovereign bonds, imitating the experience of the US Treasury bonds being taken to the London financial market and since becoming a security with the largest daily turnover in global stock markets now. In other words, China’s local debts can also be converted into government bonds and traded in Hong Kong's capital market, emerging as a security that can be traded in the secondary market. Hong Kong will in the process become the largest offshore trading center for renminbi.
However, all debts still have a date of repayment and add pressure to a country's financial burden. Excessive borrowing also hinders the robust development of the economy. Therefore, financial markets pay great attention to changes in the credit rating of government or corporate bonds. AAA+ is the best credit rating with absolutely no repayment ability problem. However, a rating below BBB+ means that the bond may default. Rating for government bonds is called sovereign credit rating.
The Federal Reserve (Fed) conducted three QE programs up to 2014. This policy positively stimulated bank lending while increasing the amount of corporate and government debts. As the debt ceiling problem cannot be fundamentally resolved, the credit rating of US government bond was downgraded to A+ in early 2023. According to the EMH, the time when downgrades are announced usually marked the lowest point of government bond prices and the highest peak of bond yields, showing a tendency of taking full advantage of a bad news. The bond market followed this tendency until 2023. However, the author found that the tendency that credit downgrades encourage the taking full advantage of the bad news has changed since the downgrade of the credit rating of the U.S. bond in early 2023. The credit rating of the U.S. Treasuries was downgraded by the Fitch Group in early 2023. However, this did not stop a rise in U.S. Treasury yields, and U.S. bond prices continued to decline, meaning that the market has not taken full advantage of the bad news.
Similarly, China's debt problems spread in the wake of the 2008 financial crisis. China launched a 4-trillion yuan program to save the economy, and the local government debt problem surfaced in 2012. Escalating debt crisis in the real estate sector and the rising unemployment rates will affect China’s economic and financial development, which in turn will hamper global economic expansion. The author expects a continuous decline of China's GDP in the future with long-term deflation and falling prices. It may become more obvious that China’s monetary policy will fall into a liquidity trap.
Looking at China's 10-year government bond yield, the trend in the future will be similar to Japan’s experience over the past thirty years. When the Bank of Japan’s monetary policy fell into a liquidity trap, the yields of government bonds continued to fall, and there was huge demand for flexible funding. If the existing monetary policy fails to work and climbs out of the liquidity trap, it will be difficult for prices to rise in more than ten years, causing deflation and a gradual decline of economic growth. If China wants to escape this middle-income trap, that is, from a per capita GDP of US$10,000 to US$13,000, it should change the current "expected" loose monetary policy like cutting interest rate and required reserve ration (RRR). China should first deleverage and then adopt innovative monetary and fiscal policies, following the example of the Fed as the latter proposed to buy QE assets in 2009. By taking these steps, China will be able to solve its current economic predicament.
(Chih-chang Chiu, Associate Professor at Tamkang University)
(Translated to English by Cindy Li)
