Bracing for deflation in China

The government must come up with longer-run measures to diversify export markets and find future growth engines for the country before it’s too late.

Fears of property-related corporate collapses have reignited in China after Country Garden Holdings — the biggest private-sector housing developer by sales — missed coupon payments to its bondholders in a grim reminder of the default crisis of property behemoth Hengda Group (Evergrande) in 2021. The company missed interest payments on its $1 billion dollar-denominated bonds on Aug. 7. It could be declared “publicly in default” if it does not pay up within the next 30-day grace period. A default of Country Garden could destabilize the property market, which accounts for a quarter of the country’s gross domestic product. That could deal a devastating blow to the Chinese economy. China could sink into a deflationary spiral if the risks spill over to the fragile finance of local governments and the financial sector.

To build apartments, Chinese real estate developers must buy the license for land use from local governments who own the land. The revenue from license sales made up 40 percent of the income of local governments as of 2021. The woes of housing developers can translate into a shriveled income for local governments. A chain default and the sprout of bad loans can impair the finance of banks who lent money to developers. The trouble therefore has implosive ramifications.

Beijing has been hastily relaxing its regulatory real estate policy to prop up the market. China has been implementing rigid regulations since five years ago with the slogan of “Homes are a place to live in, not speculate on.” The slogan was dropped from the policy guideline last month to help ease regulations on real estate.

Still, the property market is unlikely to regain its past prosperity. People are deferring housing purchases, as they expect real estate prices to fall rather than rise. The consumer price index fell 0.3 percent in July from a year ago, giving China the first taste of deflation since February 2021. A housing market shock on top of deflation could shake not just the Chinese economy but also the global economy. U.S. President Joe Biden called China’s internal problems a “ticking time bomb”.

This spells a crisis for Korea, which relies heavily on the Chinese economy. Although the share has been falling, the ratio of exports to China still accounts for nearly 20 percent. Hopes for help from China’s reopening after its draconian Covid-19 lockdowns have been dashed, bringing forth a dismal outlook for growth merely in the 1 percent range for the Korean economy next year. The Korean won has stayed subdued as a result. The government must come up with longer-run measures to diversify export markets and find future growth engines for the country before it’s too late.