China is facing a persistent consumption slowdown, which can be traced back to a deeply-rooted issue: the country’s real estate slump. This slowdown is having far-reaching effects on the Chinese economy, particularly through its deep ties to local government finances and debt. The downturn in the real estate sector, once a key driver of the country’s rapid economic growth, is now causing significant financial strain at both the local and national levels.
For two decades, real estate was the primary vehicle for Chinese household wealth accumulation. As families invested heavily in property, local governments became reliant on land sales as a major source of revenue. But in 2020, Beijing began a crackdown on the property sector, targeting developers’ excessive reliance on debt. This regulatory shift triggered a cascading set of problems, leading to falling property values and a sharp decline in land purchases by developers.
Local Government Finances Under Strain
The consequences of the real estate slump have been particularly pronounced for local governments, which rely heavily on land sales to fund their operations. According to analysts from S&P Global Ratings, the decline in land transactions has significantly impacted local government revenues, especially at the district and county levels. As Wenyin Huang, a director at S&P Global Ratings, explained, local government finances are expected to take three to five years to recover to a healthy state.
Huang warned that delays in revenue recovery could prolong efforts to stabilize rising debt levels. “Macroeconomic headwinds continue to hinder the revenue-generating power of China’s local governments, particularly as related to taxes and land sales,” she said. This situation is further compounded by tax and fee cuts implemented since 2018, which have reduced local operating revenue by an average of 10% across the country.
The pressure on local authorities to recoup lost revenue is having a ripple effect on businesses and consumers alike. Local governments, in their efforts to close the financial gaps, are digging into historical records for potential sources of back taxes. Dozens of companies have received notices to pay back taxes dating as far back as 1994, with amounts ranging from 10 million yuan to 500 million yuan ($1.41 million to $70.49 million). These tax demands, which include consumption taxes, fees for undeclared exported goods, and late payment penalties, are putting additional strain on already struggling businesses.
One notable example comes from the relatively affluent eastern province of Zhejiang. In March, regional tax authorities ordered NingBo BoHui Chemical Technology to repay 300 million yuan ($42.3 million) in revised consumption taxes, following a “recategorization” of equipment the company had produced since July 2023. Such actions reflect the government’s desperate search for alternative revenue sources amid declining land sales.
The Wider Economic Impact
The broader economic impact of China’s real estate slump is becoming increasingly apparent. Consumer spending, a crucial driver of economic growth, has been sluggish in recent months. Retail sales, while recovering slightly from their lowest levels during the COVID-19 pandemic, have not rebounded as strongly as expected. The ongoing uncertainty surrounding employment prospects and wages is contributing to consumer hesitancy. With businesses facing rising tax demands and stagnant growth, there is little incentive to hire new employees or raise wages, further dampening consumer confidence.
In fact, the pressure to recoup taxes from past years highlights the dire financial situation facing local governments. As Camille Boullenois, an associate director at Rhodium Group, noted, the scramble for new revenue sources “really shows how desperate they are to find new sources of revenue.” This desperation is undermining business confidence, as reflected in the CKGSB Business Conditions Index, a monthly survey of Chinese businesses. Since June 2023, the index has hovered around the 50-point level, indicating either contraction or expansion. In August, the index fell to 48.6, signaling a contraction in business activity.
China’s national taxation administration has acknowledged that some local governments have issued back-tax notices, but has maintained that these are routine measures “in line with law and regulations.” The administration denied allegations of a “nationwide, industrywide, targeted tax inspection” campaign, and stated that there is no plan to retrospectively investigate unpaid taxes.
Challenges in Shifting to a Consumption-Driven Economy
Amid these challenges, Chinese policymakers face the difficult task of steering the economy away from its heavy reliance on investment and toward more sustainable, consumption-driven growth. Analysts have long argued that such a shift is necessary to address the structural imbalances in the economy, but progress has been slow. “Revenue is the key issue that should be improved,” said Laura Li, sector lead for S&P Global Ratings’ China infrastructure team. She pointed out that many government expenditures, such as education and civil servant salaries, are considered essential and cannot be easily cut, unlike spending on land development.
A significant barrier to boosting consumption lies in the complex interplay of local government-affiliated business entities that have accumulated large amounts of debt to fund public infrastructure projects. These projects, often financed through local government financing vehicles (LGFVs), frequently offer limited financial returns. Alicia Garcia-Herrero, chief economist for Asia-Pacific at Natixis, described the LGFV sector as an even bigger “grey rhino” risk for Chinese banks than the real estate sector. A “grey rhino” refers to a high-likelihood, high-impact risk that is being largely ignored.
Natixis research shows that Chinese banks are more exposed to loans issued to LGFVs than to loans given to real estate developers and mortgage holders. This creates a significant risk to the financial system, as it remains unclear how local governments and banks will manage these rising debt levels. According to S&P’s Li, “Nobody knows if there is an effective way that can solve this issue quickly.” She explained that the government is trying to “buy time” to address immediate liquidity challenges, but both central and local governments lack the resources to solve the problem all at once.
Rising Debt Levels
At the national level, China’s debt-to-GDP ratio has been steadily climbing, reflecting the mounting pressure on the economy. Morgan Stanley economists Chetan Ahya and Robin Xing noted in a September report that debt-to-GDP levels have risen by nearly 30 percentage points since 2021, reaching 310% of GDP by the second quarter of 2024. The ratio is expected to rise further, to 312% by the end of the year. The economists warned that similar deleveraging efforts between 2012 and 2016 also resulted in sluggish growth and higher debt ratios. They emphasized that further delays in shifting away from investment-led growth could lead to a loss of control over inflation and property price expectations.
GDP growth is expected to rise by only 4.5% year-on-year in the third quarter of 2024, a figure that falls short of the government’s target of around 5% growth. This signals that China is struggling to reignite its economic engine, even as policymakers grapple with rising debt levels and sluggish consumption.
China’s real estate slump and its impact on local government finances highlight deeper challenges facing the Chinese economy. The once-booming property market, which fueled two decades of rapid growth, is now a source of financial strain. Local governments, heavily reliant on land sales for revenue, are scrambling to find new sources of income, while businesses and consumers remain cautious about the future. Without a clear path to boosting consumption and addressing rising debt levels, China’s economic recovery could remain subdued for years to come.
(Source:www.cnbc,com)
For two decades, real estate was the primary vehicle for Chinese household wealth accumulation. As families invested heavily in property, local governments became reliant on land sales as a major source of revenue. But in 2020, Beijing began a crackdown on the property sector, targeting developers’ excessive reliance on debt. This regulatory shift triggered a cascading set of problems, leading to falling property values and a sharp decline in land purchases by developers.
Local Government Finances Under Strain
The consequences of the real estate slump have been particularly pronounced for local governments, which rely heavily on land sales to fund their operations. According to analysts from S&P Global Ratings, the decline in land transactions has significantly impacted local government revenues, especially at the district and county levels. As Wenyin Huang, a director at S&P Global Ratings, explained, local government finances are expected to take three to five years to recover to a healthy state.
Huang warned that delays in revenue recovery could prolong efforts to stabilize rising debt levels. “Macroeconomic headwinds continue to hinder the revenue-generating power of China’s local governments, particularly as related to taxes and land sales,” she said. This situation is further compounded by tax and fee cuts implemented since 2018, which have reduced local operating revenue by an average of 10% across the country.
The pressure on local authorities to recoup lost revenue is having a ripple effect on businesses and consumers alike. Local governments, in their efforts to close the financial gaps, are digging into historical records for potential sources of back taxes. Dozens of companies have received notices to pay back taxes dating as far back as 1994, with amounts ranging from 10 million yuan to 500 million yuan ($1.41 million to $70.49 million). These tax demands, which include consumption taxes, fees for undeclared exported goods, and late payment penalties, are putting additional strain on already struggling businesses.
One notable example comes from the relatively affluent eastern province of Zhejiang. In March, regional tax authorities ordered NingBo BoHui Chemical Technology to repay 300 million yuan ($42.3 million) in revised consumption taxes, following a “recategorization” of equipment the company had produced since July 2023. Such actions reflect the government’s desperate search for alternative revenue sources amid declining land sales.
The Wider Economic Impact
The broader economic impact of China’s real estate slump is becoming increasingly apparent. Consumer spending, a crucial driver of economic growth, has been sluggish in recent months. Retail sales, while recovering slightly from their lowest levels during the COVID-19 pandemic, have not rebounded as strongly as expected. The ongoing uncertainty surrounding employment prospects and wages is contributing to consumer hesitancy. With businesses facing rising tax demands and stagnant growth, there is little incentive to hire new employees or raise wages, further dampening consumer confidence.
In fact, the pressure to recoup taxes from past years highlights the dire financial situation facing local governments. As Camille Boullenois, an associate director at Rhodium Group, noted, the scramble for new revenue sources “really shows how desperate they are to find new sources of revenue.” This desperation is undermining business confidence, as reflected in the CKGSB Business Conditions Index, a monthly survey of Chinese businesses. Since June 2023, the index has hovered around the 50-point level, indicating either contraction or expansion. In August, the index fell to 48.6, signaling a contraction in business activity.
China’s national taxation administration has acknowledged that some local governments have issued back-tax notices, but has maintained that these are routine measures “in line with law and regulations.” The administration denied allegations of a “nationwide, industrywide, targeted tax inspection” campaign, and stated that there is no plan to retrospectively investigate unpaid taxes.
Challenges in Shifting to a Consumption-Driven Economy
Amid these challenges, Chinese policymakers face the difficult task of steering the economy away from its heavy reliance on investment and toward more sustainable, consumption-driven growth. Analysts have long argued that such a shift is necessary to address the structural imbalances in the economy, but progress has been slow. “Revenue is the key issue that should be improved,” said Laura Li, sector lead for S&P Global Ratings’ China infrastructure team. She pointed out that many government expenditures, such as education and civil servant salaries, are considered essential and cannot be easily cut, unlike spending on land development.
A significant barrier to boosting consumption lies in the complex interplay of local government-affiliated business entities that have accumulated large amounts of debt to fund public infrastructure projects. These projects, often financed through local government financing vehicles (LGFVs), frequently offer limited financial returns. Alicia Garcia-Herrero, chief economist for Asia-Pacific at Natixis, described the LGFV sector as an even bigger “grey rhino” risk for Chinese banks than the real estate sector. A “grey rhino” refers to a high-likelihood, high-impact risk that is being largely ignored.
Natixis research shows that Chinese banks are more exposed to loans issued to LGFVs than to loans given to real estate developers and mortgage holders. This creates a significant risk to the financial system, as it remains unclear how local governments and banks will manage these rising debt levels. According to S&P’s Li, “Nobody knows if there is an effective way that can solve this issue quickly.” She explained that the government is trying to “buy time” to address immediate liquidity challenges, but both central and local governments lack the resources to solve the problem all at once.
Rising Debt Levels
At the national level, China’s debt-to-GDP ratio has been steadily climbing, reflecting the mounting pressure on the economy. Morgan Stanley economists Chetan Ahya and Robin Xing noted in a September report that debt-to-GDP levels have risen by nearly 30 percentage points since 2021, reaching 310% of GDP by the second quarter of 2024. The ratio is expected to rise further, to 312% by the end of the year. The economists warned that similar deleveraging efforts between 2012 and 2016 also resulted in sluggish growth and higher debt ratios. They emphasized that further delays in shifting away from investment-led growth could lead to a loss of control over inflation and property price expectations.
GDP growth is expected to rise by only 4.5% year-on-year in the third quarter of 2024, a figure that falls short of the government’s target of around 5% growth. This signals that China is struggling to reignite its economic engine, even as policymakers grapple with rising debt levels and sluggish consumption.
China’s real estate slump and its impact on local government finances highlight deeper challenges facing the Chinese economy. The once-booming property market, which fueled two decades of rapid growth, is now a source of financial strain. Local governments, heavily reliant on land sales for revenue, are scrambling to find new sources of income, while businesses and consumers remain cautious about the future. Without a clear path to boosting consumption and addressing rising debt levels, China’s economic recovery could remain subdued for years to come.
(Source:www.cnbc,com)
