China’s Real Estate Crisis and the Beginning of Economic Stagnation in China

Kim Kisoo 

Senior Research Fellow, 

The Sejong Institute 

(kskim@sejong.org)

The Chinese economy has been showing unusual signs in 2022. Although the stagnation of the Chinese economy began two years ago with COVID-19, strict quarantine measures are not the root causes of the current economic situation. Although China’s ‘Zero-COVID’ policy and its restrictions negatively affected its production and consumption, the Chinese government stresses that there was no widespread outbreak of COVID-19 as a result. The recent statistics, however, are difficult to justify with non-economic factors. Despite the first quarter’s growth rate of 4.8% and signs of economic recovery, the second quarter’s growth rate fell to 0.4%. This is the lowest growth rate after –6.8% during the first outbreak of COVID-19 in the first quarter of 2020.

Shortly after Xi Jinping's third consecutive term was confirmed, the 20th National Congress of the Communist Party of China announced that the growth rate for the third quarter was 3.9%. This reflects the difficulty in reversing the trend of slow economic growth. Forecasts of average growth rate for 2022 by the world's leading economic institutions such as the World Bank and Goldman Sachs is very low at 2.8~3.3%. China’s youth unemployment rate was also quite high at 17.9% in October while the year on year export level decreased by 0.3%. Unprecedented levels of low economic growth and economic stagnation since its economic reforms are beginning to stand out. The following accounts further highlights the degree of economic stagnation in China.

The real estate is of absolute importance in the Chinese economy. The size of the real estate industry including sales, construction, building materials, home appliances, interior design and all other related businesses amounts to as much as 30% of China’s GDP. The proportion of real estate in Chinese household assets is also very high at about 75%. Hence, real estate problems affect household economies and cause a decrease in consumption. The Chinese real estate had remained formidable until now for the following structural reasons. The Chinese economy has a unique structure in which about 43% of local government income comes from land sales. This requires a thriving market for real estate with continued land sales and construction of housing.

However, shocking realities of China’s real estate industry were recently reported. British Capital Economics revealed a month ago that as many as 30 million apartments remains unsold in 2022 with 100 million vacant apartments due to unpaid balances. The economic reason is rather simple. Unsold apartments means that too many apartments were built in terms of supply while it may also mean a decrease in the purchasing power on the demand side. As such, statistics show that housing prices in Shenzhen and Beijing were 57 and 55 times the average income. The fact that Tokyo’s figure in early 1990s before the bubble burst was 18 times the average income shows the supply-demand mismatch and the seriousness of the housing bubble in China. This makes it difficult for construction companies to collect their investment which naturally leads to banks not being able to collect their loans. What is important is that a weak financial sector is accompanied by a slowdown in the housing market.

Despite the structural weaknesses of the real estate sector, the Xi Jinping leadership has pushed for restrictive measures in the name of ‘common prosperity’ to control those who have accumulated huge amounts of wealth from real estate sales. This may have won the support of people with low income levels, but have brought about economic stagnation and a sluggish property market. History and the structural vulnerability of real estate has shown that property slump goes beyond the policy of common prosperity. In 1994, tax reforms transferred a substantial proportion of local government income to the central government. How did local governments make up for the sudden decrease in income? As ownership is not recognized, there are no property taxes in China. Thus, property taxes do not form the basis of local government income in China unlike market economies. This created an alternative which was the local governments’ monopoly on land sales payments.

A booming property market is essential to obtain funds through land sales. Conversely, a property slump means that land sales are difficult which naturally leads to a worsening of local finances. On November 25, Bloomberg reported that China’s local governments suffer from severe debt levels. It pointed out that the debt-to-income ratio of local governments soared from 76.9% in 2018 to 91.3% in 2020 and 117.8% in 2022. This confirms the relationship between the two variables of real estate and local government income. Over the past 30 years, local governments and construction companies have amassed enormous wealth from numerous housing projects, especially from apartment construction. Individuals have also made a lot of money by making speculative investments and owing several houses and apartments. It is ironic that a communist characteristic, the absence of property rights, exists amid such trend.

Interest rate cuts in the US shocked the global economy. Most countries, including South Korea, raised their interest rates which naturally led to economic recession. However, the Chinese government was surprised by the seriousness of the property slump and abandoned its principle of ‘common prosperity,’ lowering its Loan Prime Rate by 0.05% last December followed by additional cuts in April, May, and August. Furthermore, loan repayment periods for real estate companies were extended in November. But as the property market continues to freeze, questions arise on the solution. First of all, given that it’s a structural issue, the property slump will continue until an alternative to the enormous local income obtained through real estate is found. The very unusual ratio of housing prices to income and the supply-demand mismatch shows that the current property slump is the market’s movement to correct excess supply and a lack of demand. Overcoming the property slump will be difficult as China faces all these problems, When reflecting on the proportion of real estate-related industries in the Chinese economy, the reasoning behind the claim that the real estate crisis represents stagnation of the Chinese economy becomes self-evident.