Morning Brief

The Chinese boat could sink because of its own sailors

Beijing looks anxiously at China's domestic debt, but it is a mess of its own making.
Published by
Central Office
on September 27, 2022
on September 27, 2022
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China's domestic debt threatens to blow up the national economy.

China is a paradox. Its overseas investment and the gigantic financing provided by its biggest banks all around the world present an image of wealth, confidence, sustainability, and financial strength. Looking in another direction, the Chinese real estate development sector is collapsing after housing prices have fallen and the ability of the real estate developers to financially support the completion of apartments has decreased. The local governments are paralyzed with accumulated debts of over 4 trillion dollars. This image shows more instability, chaos, and lack of control, rather than the opposite.

In truth, China really is a dual country. On the one hand, rich and prosperous, while on the other, deep in debt and anxious about the future. But it is a Chinese chaos of its own making. The main reason for this is the model chosen by Beijing after 2008 to provide economic growth in the absence of an already declining trade surplus. Since the export-based economic engine started not to bring the same results as before the outbreak of the financial crisis in 2008, the central government quickly reoriented towards domestic investments in properties and infrastructure. It promoted the real estate developers and local governments as responsible with providing economic growth while the central government remained covered by any responsibility. Those elected obeyed. The local governments and real estate developers have entered a mutually beneficial relationship in the short term but toxic for the national economy of China in the long term. To begin with, in China tax revenues have remained centralized in Beijing since 1994, during the tenure of President Jiang Zemin, leaving the local treasuries devoid of serious financial resources. Those local leaders responsible with the mandate given by Beijing to provide growth and social services had to fill the void with something else and they were looking for several Beijing-approved economic tools to raise money. They did it but initiated a long but sure road to failure. In China, the local governments could not have negative budget balances, at least, not on paper and not the public institutions themselves. Therefore, the local leaders initiated a genuine business environment, backed by themselves and through which they could borrow on the capital market to raise money for infrastructure projects intended to contribute to an artificial GDP of China supported by continuous capital injections. At the same time, in China the land cannot be sold by law (it belongs to the Chinese state), but it can be leased to private real estate developers in order to contribute to the new Chinese economic growth formula by building ghost cities. The relationship between local politicians and locally focused entrepreneurs was personally beneficial. The politicians got rich as a result of the bribes obtained from the businessmen in order to bypass auctions and get important projects for whoever paid better, while the entrepreneurs accumulated wealth as a result of the high rents demanded in blocks built with little money. Both sides financed the wealth of the other, but not the wealth of China. As both sides borrowed to secure gigantic infrastructure projects, the debt levels reached unsustainable levels. Now all sides are found in a destructive relationship for the national economy. Worse, this interdependence between the real estate development sector and local governments has made Beijing unable to rely on any one to provide growth. The local governments are too indebted to be able to support those local companies through which they could obtain loans for the financing of infrastructural projects. The local banks could not support these companies either, forcing the governments to rescue both the local financial sector and the local entrepreneurs who relied on the former for lending. The fall of the local public sector was soon followed by the indebtedness of real estate developers with its great champions almost defaulting one after another. An indebted real estate development sector could no longer pay for leasing the land granted by local governments, further deepening the budget hole in the provinces. In the meantime, the central government in Beijing, after almost two decades in which it assumed too little, looks worriedly as its main pillars of economic growth are struggling to survive. Not only did the central government centralize tax revenues in Beijing, but it provided too little on the national level in terms of unemployment insurance and public services including a high-quality universal health-care system. It backs China's biggest banks and owns the national most profitable state-backed companies and facilities while entrepreneurs and local banks are as indebted as those local governments, which must somehow get enough revenues coming from nowhere to bail them out.

Yes, China really is a political-economic hybrid. Centrally rich and sustainable, while locally indebted and unbalanced.

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