[Trapped Chinese Economy]⑥ "Focus on Policy Shift for Real Estate, the Most Vulnerable Link"

Jiman-su Senior Research Fellow, Korea Institute of Finance

"Real estate is the biggest vulnerability in the Chinese economy. While China has used real estate to stimulate the economy during its period of excessive growth, it is now in a dilemma because, due to corporate debt risks, it is difficult to use real estate as a tool for economic response."

Jiman-su, a senior research fellow at the Korea Institute of Finance and an expert on the Chinese economy, diagnosed in an interview with Asia Economy on the 18th of last month that the core of the recent economic slowdown in China lies in real estate. The Chinese real estate market is acting as a bottleneck to economic growth as the downturn deepens due to falling housing prices. The real estate market slump has worsened profitability and financing conditions, leading to an increase in defaults among real estate developers and expanding related liquidity risks. In particular, ongoing instability in the real estate market is negatively affecting consumption and investment.

Jiman-su said, "The biggest difficulty in the Chinese economy is the real estate sector," adding, "The real estate industry is driving the increase in corporate debt in China, and the Chinese government is implementing policies to reduce the debt ratio of real estate companies. If the macroprudential policy of managing the debt ratio in the real estate sector continues, it will be difficult for real estate construction investment to increase, and ultimately, it will be hard to stimulate the economy." He explained that sluggish private investment is also a key factor hindering China's economic rebound, as real estate-related investment, which accounts for a large portion of private enterprise investment, is weak, thereby contributing to the slowdown in private investment.

He stated, "Restructuring and economic stimulus are a zero-sum game," and added, "The Chinese authorities are conducting two types of restructuring: adjusting the debt ratios of real estate companies and addressing excessive local government debt. To stimulate the economy, they have no choice but to ease the reins on restructuring." He emphasized, "In a situation where one must give up either restructuring or economic stimulus, the key keyword for the Chinese economy in the second half of the year is whether the Chinese authorities will shift their policy stance. It is important to watch how the Xi Jinping administration, which has so far emphasized restructuring, will change its policy direction amid the dilemma of needing to revive the real estate market to stimulate the economy." Although the core of the recent economic slowdown in China lies in weak private investment and instability in the real estate market, the causes are complex, making it difficult to achieve results with general stimulus policies such as interest rate cuts or liquidity injections.

-There are recent claims that China is experiencing a balance sheet recession similar to Japan's past experience. What is your view?

▲Looking at the real estate sector, I believe China is experiencing a balance sheet recession. In fact, the problem is not on the household debt side but the debt ratio in the real estate sector. China's non-financial corporate debt stands at 160% of GDP, the highest in the world. Considering that South Korea's is about 100%, this is very high. Especially since the core of the non-financial corporate debt problem is the sharp increase in debt among real estate companies, the Chinese authorities cannot afford to neglect real estate.

As real estate companies' debt ratios rose during China's efforts to stimulate the economy through real estate, the Chinese authorities introduced the "three red lines" regulations in August 2020 to counter the real estate bubble. The three red lines are: debt ratio must not exceed 70%, debt-to-market capitalization ratio must be below 100%, and cash holdings must be at least equal to short-term borrowings. Due to these regulations, major real estate companies like Evergrande, which was once the industry leader, fell into default due to funding difficulties. While the real estate sector was previously used to stabilize the economy, it is now difficult to use it for economic response due to corporate debt risks. The need for restructuring is strong, and the real estate downturn has continued since 2020 and has not recovered at all. The real estate slump is lowering the overall economic growth momentum and negatively affecting investment and consumption.

-China seems to have learned from Japan's balance sheet recession experience. Will China follow Japan's path?

▲China has learned different lessons from Japan and South Korea. From South Korea, which experienced a foreign exchange crisis, China learned not to fully open its capital markets. From Japan, it learned about interest rates. China does not lower interest rates much?at most by 0.1 percentage points. The People's Bank of China, the central bank, kept the benchmark lending prime rate (LPR) unchanged on the 20th of last month despite concerns about economic slowdown. They adjust the money supply rather than interest rates. Raising interest rates increases corporate burdens, while lowering them risks addiction to cheap money. Japan took a long time to deflate its bubble, but China will not. This is why the Chinese authorities are holding onto real estate despite the economic slowdown. It appears they want to avoid following Japan's path.

-With ongoing uncertainty in the real estate market, growth slowdown effects are emerging. How long will this downturn last?

▲Due to cumulative housing supply, demographic changes, slowing urbanization, and high vacancy rates, housing demand is expected to weaken and act as an additional factor slowing growth. China's per capita housing area (national average) surged from 31.1㎡ in 2010 to 41.7㎡. With a population of 1.4 billion, China rapidly increased its housing stock. Real estate investment led the economy. South Korea's per capita housing area was 33.9㎡ as of 2021. In the future, China's real estate market is expected to see a higher proportion of renovation and reconstruction compared to new housing demand. The establishment of a nationwide registration system and the potential introduction of property and inheritance taxes will likely suppress demand and negatively impact other sectors such as private investment and durable goods consumption. However, from Xi Jinping's perspective, who aims for long-term governance, real estate-related risks cannot be ignored. The maturation of the real estate market and demand slowdown are inevitable. The current problem is that the Xi Jinping administration's long-term restructuring will does not align with the current economic situation. We need to watch what decisions Xi Jinping will make to revive the economy in the second half of the year.

-It also seems difficult to restore investment sentiment among Chinese private enterprises.

▲Since its inception, the Xi Jinping administration has expressed its intention to strengthen an industrial structure centered on state-owned enterprises. Since 2018, it has introduced various regulations on platform companies and increased penalties for illegal activities. Emphasizing "common prosperity," it has suppressed or banned private education and entertainment industries. This has raised suspicions that the government is suppressing the growth of private enterprises. Even if the Chinese authorities cut interest rates or increase fiscal spending to stimulate the economy, it seems unlikely that private enterprises' investment sentiment will recover. Private enterprises want signals that are different from these. They want trust and reassurance that they will not face the social and political risks experienced in recent years. However, this requires a change in the Xi Jinping administration's policy stance and messaging. Therefore, in the second half of the year, policy messaging may be more important than stimulus policies. Strong easing messages comparable to the current strict regulatory policies are needed to restore investment sentiment.