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The economy of China is in peril. Here is what’s wrong:

China has always served as the primary catalyst for worldwide economic expansion.

However, in recent weeks, the economic deceleration of the country has caused concern among global leaders and investors, who have shifted their expectations and no longer rely on it as a stabilizing force in the face of economic vulnerabilities in other regions. Indeed, it may be argued that, after a prolonged period, the world’s second largest economy has emerged as a significant source of concern.

On Friday, the Hang Seng (HSI) Index of Hong Kong had a decline of over 20% from its previous top in January, thereby entering a bear market. The Chinese yuan had a significant depreciation last week, reaching its lowest level in 16 years. In response, the central bank implemented its most substantial defense of the currency to date by establishing a considerably higher exchange rate against the dollar compared to the projected market value.

The concern is to the deceleration of growth subsequent to an initial surge in activity earlier this year subsequent to the relaxation of Covid-related restrictions. The current economic climate is characterized by a decline in consumer prices, an exacerbation of the real estate crisis, and a downturn in export activities. The government has ceased the publication of data on youth unemployment due to its alarming severity.

In recent weeks, there have been instances where a significant homebuilding company and a well-known investment firm have failed to fulfill their financial obligations to their investors. This occurrence has reignited concerns on the ongoing decline of the housing market, which may potentially result in increased dangers to overall financial stability.

The absence of decisive actions to encourage domestic demand and concerns regarding the spread of economic challenges have instigated a fresh wave of downward revisions in growth projections. Notably, some prominent investment banks have lowered their expectations for China’s economic growth to levels below 5%.

China’s actual GDP growth projection is being revised downwards… According to a research note by UBS analysts, the ongoing decline in property values has intensified, resulting in a further weakening of external demand. Additionally, the level of governmental support provided has fallen short of initial expectations.

Previously, projections made by researchers at Nomura, Morgan Stanley, and Barclays were adjusted downward.

This implies that China may experience a substantial deviation from its publicly stated growth objective of approximately 5.5%, which could potentially lead to a sense of humiliation for the Chinese leadership headed by President Xi Jinping.

The current situation stands in stark contrast to the global financial crisis of 2008, during which China implemented the largest stimulus program globally and became the first major economy to recover from the downturn. This phenomenon represents a notable shift from the initial stages of the epidemic, during which China emerged as the sole major industrialized economy to successfully evade a recession. Why then has this happened?

Property problems

China’s economy has experienced a downturn since April, as the initial high momentum observed at the beginning of the year has waned. However, there has been an escalation of concerns in recent weeks due to the defaults of Country Garden, formerly the leading property developer in the nation in terms of property sales, and Zhongrong Trust, a prominent trust organization.

Investor sentiment was negatively impacted and parallels were drawn to the real estate crisis initiated by Evergrande’s debt defaults in 2021, following reports of Country Garden’s failure to make interest payments on two US dollar bonds.

The ongoing process of debt restructuring at Evergrade, along with the recent challenges faced by Country Garden, has sparked renewed apprehension regarding the state of the Chinese economy.

Beijing has implemented a series of supportive measures aimed at revitalizing the real estate sector. However, even the more resilient individuals within the group are currently on the verge of default, highlighting the difficulties that Beijing must confront in order to manage the crisis effectively.

Currently, there is evidence suggesting that instances of debt defaults among property developers have extended to encompass the investment trust industry, which is valued at $2.9 trillion in the country.

According to recent company announcements, Zhongrong Trust, an entity responsible for overseeing a substantial sum of $87 billion in money on behalf of corporate clients and affluent people, has encountered difficulties in fulfilling its repayment obligations for certain investment products. The outstanding amount owed to at least four companies is estimated to be approximately $19 million.

According to footage shared on Chinese social media platforms, there were recent demonstrations held by disgruntled protesters outside the premises of the trust company. The protestors were demanding the disbursement of funds related to high-yield financial products.

According to Julian Evans-Pritchard, the head of China economics at Capital Economics, there is a potential for broader financial instability if additional losses occur in the property industry.

The individual further stated that as domestic funds progressively shift towards the security of government bonds and bank deposits, a greater number of non-bank financial organizations may have challenges related to liquidity.

Debt of the local government

Another significant issue of concern pertains to the accumulation of debt by local governments. This increase in debt may be primarily attributed to a substantial decline in revenues generated from land sales, resulting from the ongoing property market downturn. Additionally, the financial burden imposed by implementing pandemic-related lockdown measures has also contributed to the lingering impact on local government debt.

The significant budgetary strain observed at the local level not only presents considerable risks to Chinese banks, but also constrains the government’s capacity to stimulate economic growth and enhance the provision of public services.

To stimulate economic growth, Beijing has implemented a series of initiatives, such as reducing lending rates and implementing policies to support the real estate market and consumer-oriented industries.

However, it has abstained from executing significant actions. According to economists and observers, the reason behind China’s inability to stimulate its economy as effectively as it did during the global financial crisis 15 years ago is mostly attributed to its excessive debt burden.

During that period, Chinese authorities implemented a fiscal package amounting to four trillion yuan ($586 billion) with the aim of mitigating the repercussions of the global financial crisis. However, the aforementioned measures, which mostly targeted infrastructure projects under government supervision, also resulted in an unparalleled expansion of credit and a substantial surge in local government debt. As a consequence, the economy continues to grapple with the aftermath of these developments, striving to regain stability.

According to Evans-Pritchard, policymakers express apprehension that implementing their conventional policy measures to address the current economic crisis, which also has cyclical characteristics, could potentially result in an escalation of debt levels that may have adverse consequences in the future.

On Sunday, leaders in Beijing reiterated their commitment to addressing the issue of systemic debt concerns at local governments, emphasizing its significance as a primary objective.

According to an official statement by the central bank, the People’s Bank of China, in collaboration with the financial regulator and the securities regulator, has expressed their commitment to collectively address this matter.

Population decline

Moreover, China is confronted with other enduring obstacles, including a population crisis and strained diplomatic ties with significant trading partners such as the United States and Europe.

According to a recent report by state-owned Jiemian.com, citing a study conducted by a unit of the National Health Commission, the total fertility rate of the country has reached a historic low of 1.09 in the previous year, compared to 1.30 observed merely two years before.

This implies that the fertility rate in China has currently declined to a level that is lower than that of Japan, a nation that has been recognized for its long-standing issue of population aging.

In the preceding year, China disclosed data indicating a decline in its population, marking the initial occurrence of such a phenomenon in the past sixty years.

According to a recent research report by researchers from Moody’s Investors Service, the aging demographics in China pose considerable obstacles to its capacity for economic growth.

The potential consequences of a decrease in labor supply and a rise in healthcare and social expenditures include the possibility of an expanded fiscal deficit and an elevated debt burden. A reduction in the size of the labor force may also lead to a depletion of domestic savings, leading to an increase in interest rates and a decrease in investment.

According to their statement, there will be a decline in housing demand over an extended period of time.

According to Evans-Pritchard, the demographic factors, such as migratory patterns from rural to urban regions and geopolitical divisions, are mostly of a structural nature and are mostly beyond the influence of politicians.

According to the speaker, there has been a significant decrease in trend growth since the onset of the pandemic, and it is anticipated to further reduce in the medium-term.

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