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Debt, demand and demographics

Can the Chinese economy avoid ‘Japanification’?

With an ageing population, rising debt and vulnerabilities in the property market, China risks following Japan’s path from runaway growth to financial crisis and stagnation. Can Xi’s government rebalance the economy and change course?

Read this article to understand:

  • The structural issues facing the Chinese economy
  • How the crisis in China’s property sector could weigh on growth
  • The potential parallels with Japan’s “lost decades”

The Chinese Communist Party Congress in October was a grand spectacle. But the political ceremony took place against a darkening economic backdrop.

China’s year-to-date GDP growth stood at three per cent as of the third quarter, according to official data, lagging the government’s annual target of 5.5 per cent.

The proximate cause of the growth slowdown is President Xi Jinping’s ongoing zero-COVID policy, which dictates stringent lockdowns to contain coronavirus outbreaks and is stoking widespread anger. In late November, a deadly fire at an apartment block in Xinjiang province sparked protests in several cities, after claims strict lockdown procedures had been a factor in the death toll.

But China also faces deeper structural problems. The population is ageing quickly and Beijing is struggling to manage an economic transition away from debt-fuelled investment towards consumer-led growth. A crisis in China’s property sector could yet spread contagion into other areas of the economy.

These factors have led some experts to draw comparisons between China and neighbouring Japan. In 1991, the bursting of an asset-price bubble brought Japan’s high-growth era to an abrupt end, inaugurating a period dubbed the “lost decades”. As in China, Japan’s ageing demographics are inhibiting government efforts to rouse the economy.

“Although there are differences, it makes sense to worry about the ‘Japanification’ of China,” says David Nowakowski, senior multi-asset and macro strategist at Aviva Investors. “The demographic trends are very similar and there is also a property crisis, as there was in Japan in the 1990s. It is possible China’s high-single-digit growth phase is coming to an end.”

Rising debt

While China is still poorer than Japan was at the time of its crash – per-capita GDP is around $12,000, less than half the $29,000 figure for Japan in 1991 – there are undeniable echoes of Japan’s debt-driven boom in the 1980s (see Figures 1-3).

Figure 1: Private debt in Japan and China (percentage of GDP)
Source: BIS, November 2022
Figure 2: Private household debt to GDP
Source: BIS, November 2022
Figure 3: Private corporate debt to GDP
Source: BIS, November 2022

After market reforms in 1978, China developed quickly via large-scale spending on physical infrastructure over the subsequent decades. Rising debt was not a problem when the economy was growing fast enough to absorb it – but that is no longer the case.

Michael Pettis, professor of finance at Peking University’s Guanghua School of Management, estimates Chinese investment started becoming less productive at some point between 2006 and 2008. Since then, debt has risen sharply, the growth rate has moderated and exports decreased in importance relative to investment.1

Property crisis

Around 25-30 per cent of China’s GDP is now associated with property or related industries, according to data from the Peterson Institute for International Economics.2 But many developers are struggling under high levels of debt. China Evergrande, the country’s biggest developer, defaulted on an international debt payment in December 2021. 

Around 25-30 per cent of China’s GDP is now associated with property or related industries

Alarmed by leverage in the sector, the government announced “three red lines” to restrict borrowing in August 2020 and house prices have since begun to decline. This has created problems not just for developers but also local governments, whose revenues from land sales have fallen, leaving them less able to service their own debts.

While the property bubble resembles Japan’s in some respects, a precise repeat of Japan’s 1991 crisis is unlikely says Amy Kam, portfolio manager for emerging market debt at Aviva Investors. The centralised Chinese government has more control over the economy than Japan’s did and will try to enact a gradual and controlled deleveraging process that may weigh on growth over a prolonged period.

Domestic demand and demographics

The big question now is what, if anything, will pick up the slack as a longer-term driver of growth as debt-driven investment wanes.

Beijing has acknowledged the need to rebalance the economy by promoting a more sustainable growth model based on domestic demand rather than debt. But private consumption’s share of GDP stands at a lowly 39 per cent, compared with 68 per cent in the US.3 Enacting a transfer of wealth and income from local governments and state-owned enterprises to consumers will be politically difficult.4

The rapid ageing of China’s population could pose a further obstacle to the government’s efforts to rebalance the economy

Another problem is that wealth in China is often held in property; as house prices fall, consumers may feel compelled to tighten their belts rather than open their wallets. And the rapid ageing of China’s population could pose a further obstacle to the government’s efforts to rebalance the economy.

Increased costs for health and social care will put a drag on government and household budgets and could inflict further economic damage on top of the unpopular zero-COVID policy.

A recent study by the International Monetary Fund (IMF) shows an ageing population tends to lower the natural rate of interest.5 Low rates of interest restrict the scope a central bank has to revive the economy during periods of crisis, as Japan has found. Deflation is another risk.

But an ageing population is not all bad news. China’s population is ageing partly because its citizens are healthier and living longer.6 And it is possible a decline in the working-age population may push up wages by boosting the bargaining power of those in the workforce, potentially helping improve consumption.

Investment implications

While China could yet avoid Japanification over the long term, many experts are revising down their outlooks for Chinese growth. The consensus among economists surveyed by Bloomberg is that growth will remain below five per cent for each year through 2024.7

Given its size, a slowdown in Chinese growth is of obvious significance to the global economy. Nowakowski argues the biggest impact of a Chinese slowdown would be felt among its main trade partners in emerging markets, along with a few advanced economies, including Germany.

A slowdown in Chinese growth is of obvious significance to the global economy

The vulnerabilities in China’s property sector carry obvious risks for investors in its domestic markets. Equity investors are concerned about potential spill-overs and the state of corporate balance sheets, along with the ongoing impact of the zero-COVID policy.

Over the longer-term, however, the need to promote greater domestic consumption could create opportunities, argues Alistair Way, head of equities at Aviva Investors.

China is likely to want to incentivise a shift of savings away from property towards financial instruments, which could benefit Chinese financial services firms. Rising domestic consumption would also benefit domestic companies in other sectors including consumer electronics and electric vehicles.

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