Yang WenandDonald Low

Opinion | How China’s hubris led to a double debt crisis, despite the benefits of forging its own path

Despite resisting the neoliberal prescriptions of international financial institutions, China’s financial system is now showing signs of stress and fragility

The country’s situation has parallels with the US subprime mortgage crisis and European sovereign debt, while also highlighting the dangers of hubris and over-confidence

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A woman walks near a construction site of apartment buildings in Beijing. Photo: Reuters

Yang WenandDonald Low

Published: 9:00am, 14 Aug 2022Updated: 6:07pm, 26 Aug 2022

In his 2015 memoir, Dealing with China, the former US Treasury Secretary Hank Paulson recalled an admonition from China’s Vice-President Wang Qishan during the global financial crisis: “You were my teacher, but look at your financial system, Hank. We aren’t sure we should be learning from you any more.”

Over the last few decades, China has benefited from forging its own path in financial development. China resisted the neoliberal prescriptions of international institutions and the United States, avoiding the premature fiscal liberalisation that led to the Asian financial crisis in the late 1990s. Beijing’s policymakers also maintained a high degree of financial repression, allowing them to channel the country’s savings into favoured sectors, contributing directly to the success of China’s export-oriented industrialisation strategy.

But China’s financial system is now showing signs of stress and fragility. The country is currently grappling with a double debt crisis that threatens to set back its efforts to become a high-income economy by the end of the decade.

The first debt crisis is a domestic one: the slowdown in the property sector that started about a year ago as a direct consequence of the “three red lines” to reduce the indebtedness of property developers and curb property speculation. The policy led instead to a domestic credit crunch and a sharp contraction in the property sector that, by some estimates, accounts for more than a quarter of China’s GDP.

This slowdown has now metastasised into a mortgage crisis as mortgage boycotts spread to over 300 projects in nearly a hundred Chinese cities. What remains unclear is whether (and how) this mortgage crisis would imperil the health of China’s banks and undermine their ability to lend in an economy that has slowed dramatically under the strain of zero-Covid.

The second crisis is overseas debt caused by too much lending to projects that the pandemic has exposed to be less than commercially viable. When Sri Lanka defaulted on its debt for the first time in its history in May this year, it was an inauspicious sign of the problems that are likely to plague China’s main overseas lending programme – the Belt and Road Initiative – in the months ahead.

China’s double debt crisis not only has striking parallels with the US subprime mortgage crisis and the European sovereign debt crisis more than a decade ago, but also highlights the dangers of hubris and the delusion that China is exceptional in its ability to avoid financial crises.