Last year was kind to the Chinese economy. Robust growth enabled the government to make headway in its efforts to contain China's mounting debt, address overcapacity and wean the economy off a credit-heavy investment model. But whether Beijing can keep up the pace of progress in the new year is uncertain. As U.S. President Donald Trump prepares to deploy more aggressive trade measures against China, he could challenge the stable trade environment that facilitated the country's economic recovery in 2017. And as the vital real estate market continues to slow down and debt keeps piling up, the central government may have to expend more resources to maintain stability.
Beijing's Economic Progress Report
To avert financial disaster last year, Beijing launched a campaign to offload some of its debt, which today totals 260 percent of gross domestic product. The central government cracked down on shadow banking — unregulated financial transactions — and property speculation as part of its deleveraging endeavor, while also taking a closer look at risky projects and overseas investment. In addition, authorities ramped up their efforts to reform China's state-owned enterprises, unwieldy companies long beset by inefficiency, overcapacity and vested bureaucratic interests that together account for one-quarter of the country's outstanding debt.
Some of these initiatives seem to have paid off. For the first time since the global financial crisis of 2008-09, the growth of China's shadow assets — a wide array of risky and unregulated investments, including wealth management products and entrusted loans — leveled off last year. State-owned enterprises, meanwhile, reported unprecedented double-digit increases in their revenues and profits in 2017 after sustaining net losses on average five years in a row. The industries with the greatest debt burdens, such as coal and steel, turned the biggest profits thanks to consolidation and measures to correct overcapacity; their performance helped to reduce the average debt-to-asset ratio for state-owned enterprises. What's more, the rate of credit growth declined, suggesting that businesses in China are using their financial resources more efficiently.
A Real (Estate) Problem
The news isn't all good, though. Despite the signs of progress in China's economy, the country amassed more debt in 2017 — a trend expected to continue for the next few years. The problem will be all the more acute this year and next when over 1 trillion yuan ($158.24 billion) worth in bonds issued by corporations and local governments — China's two biggest debtholders — reach maturity. Most of these bonds are concentrated in the real estate sector, which is starting to slow down after a boom between 2014 and 2016. Unless Beijing relaxes its grip on credit, investment and home purchases, companies and local governments may be hard-pressed to make good on the maturing bonds.
But the central government is itself partly responsible for the downturn. Policy drives the Chinese real estate market, and state-imposed restrictions have helped flatten investment and lower purchase prices in major cities such as Beijing, Shanghai and Hangzhou. As property markets neared their limits in China's metropolises, investors and corporations started turning to smaller, more affordable urban areas in the country's central and western regions as destinations for speculative investment and opportunities to unload some of their debt. The result is a precarious situation. These lower-tier cities are generally in worse financial health than are their larger, wealthier counterparts, and real estate investment already has become a central part of their economies. For most cities in western and central China, the real estate sector makes up 30 percent of GDP, while for cities in Hainan province, it accounts for as much as 85 percent. A more drastic downturn in the housing market — due to policy failure or market correction — could devastate these fragile regions, some of which have hefty debts of their own.
Beyond the potential fallout in China's less developed areas, a prolonged real estate slump could derail Beijing's state-owned enterprise reforms. The central government has rolled out several programs over the past two years, including combined capacity cuts, debt-to-equity swaps, private capital injections and mergers, to curb the bloated corporations' debt accrual. So far, these interventions have focused primarily on the roughly 100 centrally administered state-owned enterprises, in part because these corporations are easier targets compared with locally operated companies and in part because they offer a bigger payoff. The regionally and municipally administered firms, after all, are smaller operations that provide critical jobs at the local level. At the same time, however, the local and provincial state-owned enterprises, though less indebted on average than the centrally run corporations, bear some of the highest financial risks among Chinese companies. An estimated 100,000 of these firms — dubbed "zombie corporations" — operate at a loss, and most are in sectors that depend on the property market, such as steel and construction. Should the real estate industry continue to decline, China's unprofitable zombie companies may have to refinance their debt or, worse yet, default on their obligations.
The Beginnings of a Crisis?
Beijing's debt troubles don't stop there, either. Over the past three years, household debt has surged in China, climbing from 30 percent of GDP in 2012 to surpass 46 percent of GDP in 2017. At least two-thirds of that debt is concentrated in the property sector, since corporations managed to offload some of their real estate assets onto consumers during the latest real estate boom.
Notwithstanding its precipitous rise, China's household debt levels are still relatively low compared with those of other major economies, including the United States and Japan, where consumer debt accounts for 79.5 percent and 62.5 of GDP, respectively. China's high deposit rates, moreover, mitigate the risks its growing household debt debt levels pose. But on the other hand, the country's average income remains lower than that of developed states. As household debt keeps rising, it will dampen domestic consumption at the very least. And at most, it could set off a financial crisis in China, if not properly addressed.