The Eurozone is sliding into a deeper recession and more turbulence is expected. A bigger concern is the Chinese economy. Will it be a soft or hard landing? Given that it is the second-largest economy and second-largest trader in the world, it is no wonder that China’s economic outlook is of global concern. The growth of the Chinese economy has been one of the few steady engines in the global economy in recent years and, therefore, any significant slowdown in China could have serious international repercussions including Korea.
Fortunately, price pressures are easing and inflation is less of a concern and the central bank recently cut the benchmark interest rate for savers and borrowers for the first time since December 2008. Although the cut was only by a quarter of a percent, it aims to boost investment and economic growth. The government has also lowered banks’ required-reserve ratio twice since late-2011 to boost liquidity and increase lending.
Consumer spending in China, a mere 35 percent of GDP compared to around 65 percent in most developed nations, is too low. On average, Chinese households save over 30 percent of their total income. Most of the saving is to cover the costs related to old age and medical needs. As Beijing devotes more resources to healthcare and pension benefits, consumption should increase, but it will take some time.
Due to its limited domestic demand, China is heavily dependent on exports for growth - making the economy very vulnerable to international slowdowns. China’s reliance on exports and a controlled currency for growth, for instance, will be a problem if U.S. consumers continue to retrench.
Export growth has been a major component supporting China's economy, as exports constitute about 40% of the country’s GDP. A deep and prolonged recession in the Eurozone would be a major risk to the country’s exports as Europe is the largest market for China. A U.S economic slowdown, the second largest market for China, would be a double-whammy for the country.
China has a debt problem too. China's local government debt level is too high. Heavy lending practices by state-run banks in response to the Chinese government’s stimulus package in 2008 contributed to the mountain of local government debt in China.
The massive spending, however, is catching up to China as the maturity dates draw closer. The worry is that a slowdown in the Chinese economy could set off a wave of loan defaults and stagger its banking system. This could lead to a negative credit rating in China, and is therefore a risk to investors.
China has a real estate bubble. Real estate is important in any country, but it is far more important in China and has been a primary source of economic growth in recent years. A hard landing could be caused by the country’s property market bubble and the debt used to support it. The real estate bubble has led to social unrest, as many citizens are angry that they are unable to afford to buy a home. Apartments in Beijing are affordable to only the top 20 percent of earners, while a square meter of property in China costs an estimated 164 times per-capita income.
The high housing prices in China is mostly due to the government’s privatization of some urban housing in 1998. The issue is also the product of China's massive stimulus spending and lending of 2009 and 2010, which resulted in land purchases and drove up prices unsustainably. To fight the effects of the global downturn, Chinese state-owned banks lent about $3 trillion to mostly state-owned enterprises. While the money financed largely infrastructure projects, many of the loans were used to finance real-estate purchases instead.
The Chinese government policy efforts to cool down the real estate market have been successful. These policies included increases in down payments and property taxes, as well as restrictions on the number of real estate purchases. Down-payments for first homes are up to 30 percent, while down payments for second homes are up to 60 percent. The government also launched state-subsidized apartments to provide housing to citizens who cannot afford to buy a home.
Home prices have been on a downward trend since their peak around mid-2011. Data also indicates rising unsold inventories and falling sales. While this is good news, some worry that there may be a plunge in real estate values which could cause the Chinese economy to slow more rapidly than anticipated. Property construction alone accounted for 12% of the nation’s GDP in 2011. By some estimates, half of China’s GDP is linked to real-estate related activities. The health of Chinese real estate is also crucial to China's construction, steel and cement sectors, and prices for key industrial metals used in construction have already begun to soften.
For this reason, there is worry that a significant fall in housing and apartment prices would have profound consequences for Chinese industry and investment, and lead to a rapid slowdown for the economy.
Further, since state-owned enterprises used loans to purchase property, they have taken on heavy real-estate debt. A burst in the real estate bubble means that the fall in prices could produce an overwhelming number of nonperforming loans. Therefore, many fear that a burst in the real estate market in China could lead to a banking crisis which would drastically undermine the Chinese economy.
In short, China has three major problems: the Eurozone, the provincial and local government debts and the real-estate bubble. Will China have a hard or soft landing? The question should be which part of China will have hard landing. Beijing can manage an overall soft landing for the economy. However, real-estate and some export-related businesses could face rough landing.