The bubble has burst. The phenomenal growth story of the Chinese economy is drawing to a close. After a Covid-induced 6.8 percent shrinkage of the economy in the first quarter of 2020, now in the second quarter of 2022 the growth rate has come down to just 0.4 percent.
While a draconian lockdown imposed for a two-month period from March 2022 to May 2022 to enforce an overcautious zero – Covid policy could be the immediate reason between the latest fall in growth rate, the underlying malady could be much deeper; reasons like a slump in the real estate sector of the Chinese economy, a policy of inducing growth through investment in infrastructure that has little productive use and sinking of resources in bad investments overseas though the Belt and Road Initiative in an anxiety to make strategic inroads in the recipient countries.
The immediate cause for the downturn was the lockdown imposed in Shanghai and other cities in April 2022 that stifled the economy. Retail sales went down by 11 percent during this month, with repeated shutdowns and uncertain business conditions devastating entrepreneurs. The reason for the harsh lockdown was that Xi Jinping did not want to take any chances with Covid-19 before his re-election to the post of President for a record third term.
Now with the Communist Party of China announcing on July 28, 2022, after a planning meeting, that there would be no let-up in the strict anti-Covid measures, there is little hope that the Chinese economy would revive in the coming months. Nor would the official growth target of 5.5 percent for 2022-23 be achieved. A year ago, the growth rate was just 2.5 percent.
With the receding growth rate of the Chinese economy now appearing to be a long-term trend, experts are of the opinion that the story that the Chinese economy is poised to overtake the U. S. economy and China would emerge as the prima donna of all nations will turn out to be just a fiction. “Slowing growth would make it clear that China cannot really establish a meaningful economic lead over the US. It has important implications for perceptions about where the world is headed,” chief economist Ronald Rajah of Sydney – based Lowy Institute has been quoted as saying.
Indeed, with its primary focus on ensuring a spectacular rate of growth and gaining political and strategic upper hand, the Communist Party of China has made all kinds of unsound economic decisions that have made its growth rate unsustainable in the long run. Economics, incidentally, has never been the strong point of communists.
Within China, there has been a spate in companies defaulting on their bond repayment. The most worrisome instance is that of Evergrande, China’s biggest real estate developer, that reportedly defaulted in 2021 in repayment of its $309 billion debt. There are other instances also. An auto group with ties to BMW had not been able to redeem its bonds. Companies in the coal and electricity sector and in electronics have also defaulted on bond repayment.
Bizarre stories are emanating from the real estate sector in China which indicate that the situation is really desperate. The most talked-about one is of a real estate developer in east China declaring buyers could pay for dwelling units in watermelons; 5,000 kg of the fruit and 100,000 yuan. Another is the authorities in China demolishing 15 skyscrapers with five tonnes of explosives in the second half of 2021. The buildings, unoccupied for almost a decade, were becoming an eyesore.
This is the story of the housing sector in China today, houses with no residents, commercial estates with no offices and localities with no communities.
The real estate boom started in China in 2008, riding high on the spirit of the Beijing Olympics. On an expectation of growing urbanization and increase in housing demand in cities, capital was made available to developers in the form of loans at low interest rates; with the backing of the state. With generous amounts pumped into the real estate sector as loans, the debt-to-GDP ratio of China climbed from 150 percent in 2008 to more than 260 percent in 2016. The building spree aided other sectors of the economy as well, accelerating the overall economic growth. China’s real estate sector and the related activities accounted for 30 percent of the economy of the country.
Since 2015, however, the boom in the real estate sector has started to recede, with ghost cities beginning to emerge. The housing sector is saddled with a surplus. Even if Beijing wants the construction boom to continue, the expectation is not going to be fulfilled as the fundamentals are not there. The process of urbanization is tapering off. The rate of growth of population in towns and cities dropped below one percent in 2021, the first time since 1996. Even the overall population growth is slowing. According to World Bank data, the population growth in China was 0.1 percent in 2021, compared to the previous year. By 2025, the growth rate in population may even turn negative.
The upshot is that after 15 years of unchecked expansion in infrastructure, now there is no market for real estates. Cash-strapped builders are not in a position to complete projects. Close to $590 billion is being attributed to unfinished real estate projects in China.
The study by the Lowy Institute says even if China can avoid a financial crisis from the decline in the housing sector because of unpaid debts by the real estate giants, lower investment would drag the overall growth in the gross domestic product to an average of about four percent for the rest of the current decade.
The moral of the story of the real estate sector in China is that in their anxiety to prop up an unsustainable rate of growth the mandarins of the Communist Party of China have encouraged bad investment. With state-intervention, the checks and balances of the market forces have been done away with. As the market for real estate was becoming saturated, the signals emanating from the market like falling prices and unsold apartments were ignored and more money was pumped in to ensure a high rate of growth, thus deepening the crisis.
In a market economy, the ups and downs of a business cycle are a regular phenomenon; the downswings help prevent the economy overheating at times of boom. Always anxious to ensure a high rate of growth, the mandarins of the Communist Party of China are not ready to accept the downswings of a business cycle. For, the legitimacy of the rule of the Communist Party of China depends on ensuring a high rate of growth. Now, the Chinese economy has tripped badly.
As the World Bank has pointed out in a study: “China remains tied to the old playbook of boosting growth through debt financed infrastructure and real estate investment.” The overcapacity in the real estate sector has rendered many corporates as well as local governments indebted. The local governments in China acquire rural land for real estate development and sell it at a profit.
The policy makers in Beijing have typically reacted to the crisis posed to the economy by the slump in the real estate sector by investing in the creation of more infrastructure elsewhere. Unfortunately, these infrastructure projects produce rapidly declining returns for the economy. Much of these infrastructure projects are unnecessary.
On July 20. 2022, Beijing announced the plan to build a new highway along the Line of Actual Control with India; all the way from Lhunze county in Tibet, bordering Arunachal Pradesh in India, to Kashgar, Xinxiang region, bordering the Ladakh region of India.
While the construction of the road has been planned to strengthen the strategic position of China and project its power, observers have said the real reason is to shore up the falling rate of growth of the Chinese economy through a new avenue of investment. Besides military use, however, such a road would have little role in contributing to the economy of either mainland China or Tibet, and would in the long run be another bad investment without any economic return.
To make strategic inroads in developing countries, state-owned Chinese enterprises have lent them large amounts in unsustainable projects through the Belt and Road Initiative. Unable to reap any return from these projects, the recipient countries are now registering debt defaults. They are unable to pay back to the Chinese companies their debts.
The classic instance is the Hambantota Port in Sri Lanka which is of little commercial value. Among the major China Pakistan Economic Corridor projects in Pakistan, there is almost no commercial shipping at Gwadar Port and the Lahore Metro appears to be economically viable. Beijing could be sinking money in such commercially unviable projects to gain geo-strategic advantage but the backlash of unsound economic decisions is just waiting to be felt by China.