The Chinese economy is facing debt defaults of property developers and high youth unemployment. US credit rating agency Fitch Ratings again downgraded the sovereign credit rating of China’s government bonds on December 13th, 2023. The agency analyzed the Chinese government’s future budget revenue and expenditure and ability to repay debts based on current economic situation and concluded that China will be facing a bleak economic outlook in 2024. Its projected annual GDP growth will be cut from 5.4% to 4.7%. According to Fitch, such economic slowdown will affect China’s ability to pay back debts. As a result, its sovereign credit rating was downgraded to A+ with a Stable Outlook from A+ with a Positive Outlook.
The announcement seems to dampen the enthusiasm of China’s just-concluded annual economic work conference. The author found that the U.S., the Eurozone and China, the three largest economies of the world, have successively witnessed excessive debt exceeding or on the brink of default after the burst of asset price bubbles. These events mainly began emerging due to the fact that EU, the U.S. and China continuously promoted loose monetary policy and low interest rates in the past twenty years, which encouraged companies to actively expand and resulted in asset bubbles and inflation. The three economies gradually fell into debt turmoil in the end.
In response to the financial tsunami, China adopted a monetary easing policy and launched a four trillion-yuan bailout plan in 2009. The scale of outstanding local government debt grew increasingly large after 2015. Enthusiasm for real estate investment among the Chinese people became an engine driving economic development after 1998. However, Xi Jinping gave a stern warning that “houses are for living, not for speculation” at the economic work conference in December 2016. Trade war between the U.S. and China began in 2018, shaking the confidence of foreign firms in China. A real estate bubble appeared, and the situation took a sharp turn for the worse in 2019, when 450 real estate companies went bankrupt. The Central Committee of the Communist Party of China (CPC) started to address the debt problems of real estate companies and drew several red lines in August 2020. Evergrande could not cash its cheque for the first time in November. Since then, County Garden and a group of real estate developers successively defaulted on their debt.
Facing the risk of collective debt default by real estate developers, China is seeking diversified solutions. First, China asks state-owned enterprises (SOEs) to purchase the physical assets of the developers and use price control to prevent developers from irrationally selling off to get cash. Second, China deals with the follow-up management of bonds issued by developers, either replacing old debt with new one or debt restructuring. Third, China is adopting a long-term loose monetary policy in line with the collapse of its core sector. Even as the U.S. faced inflation in 2021, China has not experienced such atmosphere with prices falling instead since 2020. Fourth, in terms of bailout methods, China has launched two robust approaches to stimulate consumption and expand infrastructure. The former is a subsidy for the purchase of electric vehicles, and the latter is constructing local infrastructure. These are similar to the four trillion-yuan stimulus plan in 2009 but with diminishing marginal benefits. Fifth, China needs to solve the problem of debt deflation. China deliberately keeps lowering the interest rate for renminbi in the hope of depreciating its currency to bolster exports. However, amid weak global purchasing power, China’s efforts to increase competiveness by yuan depreciation only yield very limited effect on trade surplus.
For a country to achieve continuous and stable economic growth and face debt risks, the first priority is to end expansion, clear excess capacity and stop using borrowed money to expand. Urbanization may slow down the worsening of excessive real estate supply. But the most important thing is how to deleverage and avoid further borrowing. Back to financial theories, the reality is to strengthen the capacity to repay debt. The financial indicators of debt repayment are current ratio and quick ratio. Increase in current ratio is due to increase in asset value, including the rapid conversion of accounts receivable into cash and increase in inventory value. The way to enhance quick ratio is to quickly convert inventory into cash. These financial management methods require vigorous, frequent and surprising monetary and fiscal policies. Stability will be the growth model most needed in China in the future. In the process of debt deleveraging, the most basic requirement for solving debt problems is to avoid raising debt for large-scale expansion and adopt a down-to-earth approach. What China needs is not price control but setting a strict limit on debt expansion.
(Chih-chang Chiu, Associate Professor at Tamkang University)
(Translated to English by Cindy Li)
