China’s Looming Financial Crisis: Unpacking the Risks, Realities, and Global Ramifications

Recent data from an International Monetary Fund (IMF) report last week has indicated that a financial crisis in China is no longer unthinkable. One of the world’s preeminent emerging economies is now bracing for cover as a deflating property bubble, local governments struggling to service their debts, and geopolitical tensions are prompting concern.

In the report from the IMF, China’s economic growth stood strong at 4.9% this year through the third quarter. However, the IMF only sees Chinese economic growth averaging just 4% over the next four years, down 0.6% from last year’s projection. How does a 0.6% projection decrease make a difference?

China has the world’s second-largest economy with $18 trillion currently in gross domestic product (GDP). China also has a consumer market of 1.4 billion people. Any stumble in the Chinese economy is likely to send shockwaves around the world and through the global markets. Economists are closely watching two major sectors of China’s economy for any activity that could trigger a downturn.

First, China’s real estate industry is causing concern for an impending financial crisis. In 2022, the China Evergrande Group became insolvent and set off defaults across the housing industry and effectively bursting the real estate bubble. This year, the largest privately run property developer, Country Garden, is also fighting to avoid the same fate at Evergrande. As of June 30, Country Garden reported a first-half loss approaching $7 billion after writing down property developments and assets.

This hit to the real estate industry casts larger effects on the Chinese economy as a whole. City and provincial governments historically derived a large portion of their land sales to private developers, such as Country Garden. Additionally, the trouble with developers deflates consumer confidence in housing. Chinese citizens are less likely to view real estate as a sound investment, which could be devastating as the real estate and related industries contribute to nearly a quarter of the Chinese’s total GDP.

Second, local Chinese governments have been struggling to service their debts as land sales, as seen through the aforementioned real estate bubble burst, have started to dry up. The IMF has estimated 30% of local government financing vehicles are not viable without government support. Simply put, the local and provincial Chinese governments are going to need to start turning to the State for help repaying their debts.

The issue with turning to China’s banks for help paying the debt is that the banks themselves hold roughly 80% of that debt. Restructuring this debt could cost nearly $465 billion in impairment charges. This cycle of debt illiquidity could lead Chinese banks to lend less. Without borrowing, the local governments in need of the money, as they previously were unable to service debts, could start cutting down investment into communities and social services. Weaker local governments also impact relative property values in the area, which have already been under pressure.

The question we are left with is, “well, then how bad can this really get?”

Expert economists do not have an exact answer, although they have been cautiously optimistic that any financial crisis would not resemble that of the 2008 Recession. In their analysis, economists rely on China’s “Too Big to Fail” mentality with their banking system, citing strong balance sheets as evidence.

However, the global interconnectedness of the financial markets could move the possibility of a crisis into unchartered territory. Pure financial metrics aside, the current state of Chinese-American trade relations, ongoing conflict with Ukraine and Russia (who China has historically backed), and the recent actions in Israel and Gaza have the international community concerned for the way these events can compound the pressure the Chinese economy is already feeling.

As the headwinds start to strengthen against China, it is important to recognize the way “financial contagion” could negatively affect the global markets.

Article Written by Gabriella Amaturo

Sources:

Greg Ip, A Financial Crisis in China Is No Longer Unthinkable, Wall St. J. (Oct. 19, 2023 12:03 AM ET), available at https://www.wsj.com/world/china/dont-rule-out-a-financial-crisis-in-china-ed048ef9?mod=economy_lead_pos2 (last visited Oct. 20, 2023).

Rebecca Feng, An Even Bigger Housing Crisis Threatens China’s Economy, Wall St. J. (Sept. 18, 2023 12:01 AM ET), available at https://www.wsj.com/world/china/china-economy-housing-country-garden-ea0db13f (last visited Oct. 20, 2023).

Nick Marsh, What China’s economic problems mean for the world, BBC (Sept. 29, 2023), available at https://www.bbc.com/news/business-66840367 (last visited Oct. 20, 2023).

Richard Haass, China’s Homegrown Crisis, Council on Foreign Rels. (Aug. 21, 2023 04:35 PM ET), available at https://www.cfr.org/article/chinas-homegrown-crisis (last visited Oct. 20, 2023).

Charlie Campbell, China Faces a Familiar Economic Downturn. But Its Crisis IS Worsened by the War in Ukraine, TIME (Sept. 15 2023 02:15 AM ET), available at https://time.com/6314365/china-economy-russia-ukraine-war/ (last visited Oct. 20, 2023).