When China abandoned its lockdown-heavy “COVID zero” policy late last year, it was widely predicted that the nation’s economy would boom as trade and travel returned to normal. But in the months since, consumer spending has been anemic, the property market—which has been labeled a “ticking time bomb”—continues to struggle after years of overbuilding, and government officials are struggling to cope with $23 trillion in unmanageable local government debt as well as rising youth unemployment.
Now, some economists fear China is headed for an insidious type of recession that will keep its economic growth subdued for years to come. “China is entering a balance-sheet recession…people are no longer borrowing money,” Richard Koo, chief economist at the Nomura Research Institute, the research arm of Japan’s biggest investment bank and brokerage, told Bloomberg Friday.
Koo defines a balance sheet recession as a period during which consumers and businesses put more of their money towards paying down debt instead of spending or investing. The economist developed the balance sheet recession concept based on Japan’s “Great Recession” that began in 1990 and kicked off what many now call the country’s “lost decades”—a period when economic growth was routinely well below the average for developed nations and deflation was a constant threat.
Koo argues that when a balance sheet recession hits and businesses turn from their typical goal of profit maximization to debt minimization, it can slow economic growth to a near standstill. This balance sheet recession was a key reason for Japan’s descent into a period of low economic growth and low inflation in the 90’s, according to the economist, and for its slow recovery from the Global Financial Crisis of 2008.
Koo’s fears for China’s future aren’t unfounded. The latest China Beige Book survey, which uses proprietary data to get insights about the health of the sometimes opaque Chinese economy showed that national borrowing in the country fell to its lowest level since 2010 in the second quarter, CNBC reported Thursday. “The fact that companies — which should be borrowing and expanding — are not doing so suggests that entrepreneurs are worried,” Koo wrote about the data.
While the U.S. Federal Reserve and many other central banks worldwide are raising interest rates to fight inflation, China has been heading the other direction. Inflation isn’t an issue in the nation—year-over-year consumer price increases were just 0.2% in May—but fading economic growth is becoming one. That led the People’s Bank of China to cut interest rates last August, and again this month, in hopes of spurring demand for goods and services.
Despite the rate cuts, China’s real estate market continued to show weakness in the latest China Beige Book survey, with realtors reporting declines in both sales and prices. And new Purchasing Managers Index (PMI) data released Friday by China’s official statistics agency showed that the manufacturing sector contracted for the third straight month in June. The non-manufacturing also weakened, with PMI dropping from 54.50 in May to 53.2 in June, but remaining above the key 50 cutoff level that indicates contraction.
Employment also declined in both sectors, which is bad news for China’s youth who have been struggling with a sky-high unemployment rate for years. Although China’s overall unemployment rate was just 5.2% in May, the jobless rate for those aged 16 to 24 hit a record 20.8%.
The good news, according to Nomura, is that China’s government is already well aware of its economic problems and is taking steps to address them.
“There are already people talking about a balance-sheet recession in China — that was not the case in the U.S. in 2008 or Japan in 1990. The key difference is now the doctor knows what the disease is,” he said. “If the government puts in speedy, sufficient and sustained fiscal stimulus, then there’s no reason for Chinese GDP to collapse.”
However, while China has been able to use fiscal stimulus to boost economic growth in the past, the tactic has also led to issues with oversupply in the property market and exacerbated surging local government debts—it’s been a double-edged sword for the economy. That could mean President Xi Jinping’s options to stimulate his economy are limited.
“We’re caught in a kind of vicious circle in the sense that you need a massive stimulus to create a little moderate impact,” Keyu Jin, an economics professor at the London School of Economics, told Bloomberg Friday.
