Is China facing a lost decade?

A man looks thoughtful on a street, in the middle of a hot day in Shanghai, in July 2023 (Reuters) (ALY SONG/)

Since the Chinese real estate bubble burst“, said Richard Kooof the Nomura Research Institute, in a recent talk, “I have been receiving tons of calls from Chinese journalists, economists, investors and sometimes policymakers asking me: “Shall we go the way of Japan?””.

Mr. Koo is the right person to ask: he has dedicated his career to studying the aftermath of financial excess. When the recovery of the US economy after the first Gulf War faltered in 1991, his then boss at the Federal Reserve from New York, Edward Frydl, began to worry about excess debt and commercial properties. This was “fueling widespread financial and economic conservatism among businesses and consumers,” he argued. Frydl. The demand for credit was low, because companies “directed their efforts towards restructuring their balance sheets”. To describe these tensions, he coined the term “balance sheet recession.”

Later, Koo he realized that Japan He suffered the same problems, but much worse. After the stock market bubble burst in 1989, share prices plummeted 60% in less than three years. House prices in Tokyo fell for more than a decade. Deflation, by some measures, persisted even longer. Even the price of golf tickets, which are traded on organized exchanges in Japan, plummeted by 94%. Many companies, which had gone into debt to buy property or shares in other companies, found themselves technically insolvent, with assets worth less than liabilities. But they still had liquidity, with sufficient income to meet ongoing obligations. With survival at stake, they refocused their efforts from maximizing profit to minimizing debt, as Koo said..

In a healthy economy, companies use the funds contributed by households and other savers and invest them in the growth of their businesses. In it Japan Post-bubble, things looked different. Instead of raising funds, the business sector began to repay debts and to accumulate their own financial rights. Its traditional financial deficit became a chronic financial surplus. Business inhibition deprived the economy of much-needed demand and business vigor, condemning it to a decade or two of deflation.

Is China going the way of Japan? Chinese companies have accumulated even more debt, relative to the size of the country’s GDP, than Japanese companies in their bubble era. House prices in China have begun to fall, damaging the balance sheets of households and real estate companies. Credit growth has slowed sharply, despite interest rate cuts. And the flow of funds statistics show a reduction in the financial deficit of Chinese companies in recent years. In the opinion of Mr. Koo, China It is already in a balance sheet recession. Add to this a declining population and USA hostile, and it is easy to be pessimistic: will it go the way of Japan? I should be so lucky.

But if you look more closely, the case is less conclusive. Much of the debt incurred by Chinese corporations corresponds to state-owned companies that will continue to borrow and spend, with the support of state banks, if Chinese policymakers demand it. Among private companies, debt is concentrated on the books of real estate developers. These are reducing their liabilities and cutting investment in new real estate projects. But with falling real estate prices and weak home sales, even developers with strong balance sheets would be doing the same.

The end of the real estate boom in China has made households less wealthy. Presumably this is encouraging conservatism in their spending. It is also true that in In recent months, households have repaid their mortgages early, which has contributed to the sharp slowdown in credit growth. But surveys show that household debts are low relative to their assets. Prepaying their mortgages is a rational response to changing interest rates, not a sign of stress on their balance sheets. When interest rates fall China, households cannot easily refinance their mortgages at lower rates. Therefore, it makes sense for them to pay off older, relatively expensive mortgages, even if it means rescuing investments that now offer lower returns.

What about the change in corporate behavior revealed by China’s flow of funds statistics, which show the corporate sector moving into a financial surplus? According to Xiaoqing Pi and his colleagues from Bank of America, this narrowing is largely due to the crackdown on shadow banks. If financial institutions are excluded, the business sector continues to demand funds from the rest of the economy. Chinese companies have not made the collectively counterproductive shift from maximizing profits to minimizing debt that doomed Japan to a deflationary decade.

Japanese lessons

These differences show that China It is not yet in a recession similar to that of Japan. and his own Koo is willing to highlight a “huge” difference between the two countries. When Japan was falling into a recession, no one in the country had a name for the problem or an idea of ​​how to combat it. Today, she says, many Chinese economists study his ideas.

His recipe is simple. If households and businesses don’t borrow and spend even at low interest rates, the government will have to do it instead. Fiscal deficits must offset the financial surpluses of the private sector until their balance sheets are completely healthy. Yeah Xi Jinpingthe Chinese ruler, receives adequate advice, will be able to fix the problem in 20 minutes, he said Koo.

Unfortunately, Chinese officials have so far been slow to react. The country’s budget deficit, broadly defined to include various types of local government borrowing, has tightened this year, worsening the recession. The central government has room to borrow more, but seems reluctant to do so, preferring to keep its powder dry. This is a mistake. If the government spends late, it will probably have to spend more. It is ironic that China risks falling into a prolonged recession not because the private sector intends to clean up its finances, but because the central government is not willing to dirty its own balance sheet sufficiently.

© 2023, The Economist Newspaper Limited. All rights reserved.