China’s two-decade growth surge, driven by factors such as liberalization of land development, accelerated urbanization, increased homeownership, entry into the WTO, and industrial policies, may be at risk due to shaky financial foundations. One major concern is the massive debt accumulated by Local Government Financing Vehicles (LGFVs), which borrow money to build infrastructure. LGFVs have amassed $9 trillion in debt, equivalent to half of China’s total GDP, often requiring operating subsidies and leading to financial distress. The Chinese government has approved new provincial debt to support faltering LGFVs, but this exacerbates long-term debt and fiscal challenges for local governments.

Another concern is the falling housing prices in the wake of COVID, leading to slower growth in the property sector. Private real estate developers, like Evergrande and Country Garden, have borrowed extensively to build homes and office buildings. However, many of these projects have become financial burdens, including the creation of ghost cities, resulting in unsold apartments and undelivered homes. Trust companies, which sold exotic products promising high returns, have also invested in non-transparent assets, further adding to the financial risks.

China’s banks are heavily exposed to local government debt, property-backed loans, and mortgages. If promised homes are not delivered or real estate loses value, many of these loans may go unpaid. A potential bankruptcy of a major developer like Country Garden could strand millions of buyers. The cracks in China’s industrial policies are also becoming apparent, as protectionism, subsidies, and technology theft have driven advancements in various industries. However, foreign companies are becoming cautious about China, with concerns about subsidy-countervailing duties and a decline in foreign investment.

As China’s economy recovers from the COVID lockdowns, it is expected to expand around 4.5% this year. However, in the long term, the Chinese government will need to address the risks posed by its financial challenges. If they fail to do so, there is a possibility of zombie enterprises, a lost decade similar to Japan’s experience, and potential inflation.

Sources:
– [Source 1]
– [Source 2]