[Trapped in the Chinese Economy]⑫ "Seize Opportunities Amid US-China Rivalry, But Avoid Becoming a Bullet Sponge"

Interview with Lee Chi-hoon, Head of Emerging Economies at the International Finance Center
"China's 'growth through debt' lacks confidence, leading to economic contraction"
"Overcoming semiconductor regulations is key to the power struggle"
"Must seize more of the China market and invest in technology development"

"If the United States restrains China, it will help our country's companies maintain the technological gap with China. We must seize such opportunities but avoid becoming the scapegoat by leading anti-China regulations first."

Lee Chi-hoon, Head of the Emerging Economies Department at the International Finance Center, recently emphasized in an interview with Asia Economy that for South Korea to survive between the U.S. and China, a meticulous strategy is needed to capitalize on opportunities while minimizing risks. He explained that while the U.S. pressures China, South Korea should increase exports to the U.S. market and simultaneously minimize conflicts with China to export more there as well.

In particular, Lee stressed the importance of investing in technology development to reduce dependence on imports from China. He pointed out, "Since China controls global mines, realistically, to reduce import dependence on China, we need to develop new materials that can replace them. We must invest more in areas where we can have a technological advantage over China."

Regarding the recently sluggish recovery of the Chinese economy, he acknowledged clear risks but also explained that China has the capability to overcome them. He said, "With the U.S. regulating semiconductors, economic sentiment in China is shrinking, and private sector investment and consumption are becoming unstable. However, China already tightly controls a significant portion of IT components, the materials used in them, and battery supply chains, so it would be burdensome for the U.S. to engage in an all-out confrontation with China."

Below is a Q&A with Mr. Lee.

Ichihun, Head of Emerging Economies Department, International Finance Center. Photo by Younghan Heo younghan@

- Recently, the Chinese economy has not shown a rapid recovery. What are the reasons?

▲ In the past, China achieved high domestic and international growth through multiplier effects by government-led large-scale infrastructure and real estate investments. However, now the efficiency has declined, and large-scale investments are not occurring. Households and companies no longer expect high growth as before, so they are reluctant to take loans. The economy needs to be revitalized through consumption and domestic demand stimulation, but since there is no longer confidence in 'growth through debt,' the economy is contracting.

- How serious is the Chinese debt situation?

▲ I do not agree with the view that China's economic system will collapse due to high corporate debt problems. Chinese state-owned enterprises hold substantial deposits, which can mitigate debt risks. However, due to continuous stimulus policies by Chinese authorities, some marginal companies have been artificially kept afloat. Large companies like those in telecommunications are competitive, but many others are not. In a situation of deepening polarization, the debt of non-competitive marginal companies is at high risk of becoming non-performing.

Local government debt is also a problem. With fiscal capacity reduced due to COVID-19 lockdown policies, some local governments are under heavy burdens. The debt issue of 'LGFV (local government financing vehicles),' special entities for local government financing, is also unclear. While local government debt may not lead to a national economic crisis, it can reduce growth momentum. The biggest problem is that the real estate market is linked to local government debt. Since about 25% of government fiscal revenue comes from land use rights sales, a poor real estate market directly affects government revenue.

- To revive the sluggish economy, bold stimulus measures are needed, but debt makes this difficult.

▲ Restructuring marginal companies and improving productivity can be prerequisites for China's medium- to long-term economic growth. China has attempted reforms before but has repeatedly halted them due to crises such as the global financial crisis, U.S.-China disputes, and COVID-19. Also, restructuring can reduce employment and lead to political instability. The current situation is similar. However, unlike before, the Chinese government's fiscal capacity is not large enough to maintain marginal companies indefinitely, and local government debt issues are serious. China needs further structural reforms.

- What is the outlook for the Chinese real estate market?

▲ It is difficult to expect a return to the boom of the past. Prices are too high. The PIR (price-to-income ratio) is among the highest globally. Four of the world's top ten most expensive cities are in China. Since the willingness to invest using loans has greatly decreased, there are significant concerns about a real estate bubble. The structure where local governments provide loans through subsidiaries with real estate as collateral means that a real estate downturn affects the entire Chinese economy and politics. It is the biggest factor limiting China's economic recovery.

- The U.S. is strengthening pressure on China with advanced semiconductor export regulations. How much impact is this having on China?

▲ The pressure is significant from China's perspective. With local government debt, real estate downturn, and the inversion of U.S.-China interest rate differentials, China is in a difficult situation, and continued U.S. pressure increases the risks China faces. China is trying to overcome the crisis through productivity improvement and fostering advanced industries, but U.S. regulations on advanced industries, especially semiconductors, are shrinking economic sentiment and destabilizing private sector investment and consumption.

- Is there a possibility that China will follow Japan's path of the 'Lost 20 Years'?

▲ The difference between China and countries like Japan, Germany, or Russia (which lost to the U.S. in the past) is the economic scale. China has a massive domestic market. Many foreign companies, including American ones, are already in the Chinese market and oppose efforts to contain China. China already tightly controls a significant portion of IT components, the materials used in them, and battery supply chains. It would be burdensome for the U.S. to engage in an all-out confrontation with China.

According to IMF projections, if China's economy performs poorly, it is expected to maintain growth in the 3% range; if well, mid-4% range. This is too high growth to compare with Japan's 'Lost 20 Years.' Unlike Japan in the past, China's export dependence relative to GDP is about 18-19%, which is much lower. With low external dependence and a large domestic market, the possibility of a long-term stagnation like Japan is small.

- Is there a possibility that China will win the hegemony competition against the U.S.?

▲ It cannot be ruled out. China already holds an advantage in next-generation advanced industries such as 5G and renewable energy. The U.S. leads in aerospace, but China ranks second or third globally. China lags significantly in semiconductors, which is why the U.S. focuses on semiconductor regulations against China. Semiconductors have a large impact on other industries. If China cannot overcome this, it cannot beat the U.S., but if it achieves remarkable growth in semiconductors, it could surpass the U.S.

- How should South Korea respond amid the U.S.-China hegemony conflict?

▲ If the U.S. restrains China, it helps South Korea maintain the technological gap with China. Also, the sales of our companies competing with China increase significantly. We must maximize that. However, while seizing opportunities, we must not become the scapegoat. We should not withdraw too much from the Chinese market. Although the U.S. and China are in conflict, we should not be the first to push for regulations against China. While there is strong U.S. pressure and ideological alignment, from an economic policy perspective, we should strive to maintain relations with China.

- As U.S.-China conflicts intensify, the need for South Korea's 'de-Chinaization' is growing.

▲ De-Chinaization does not mean reducing exports to China. We must fully compete to capture more of the Chinese market and simultaneously grow other export markets to reduce China's share. China, with the world's largest market, cannot be replaced by India. The agreement on de-Chinaization concerns import dependence. Of course, parts of the supply chain dominated by China, such as lithium, are difficult. China controls mines worldwide. It is said that for South Korea or advanced countries to produce these domestically, environmental impact assessments alone take about three years. Realistically, to reduce import dependence on China, we need to develop new paradigm materials that can replace them.