Could China be ‘turning Japanese’?

The economic growth of China is among the world’s spectacular phenomena. China outstrips Japan’s and South Korea’s rapid economic growth rates; sometimes by double digits.

The two predecessors fell into crises: Japan in 1990 and South Korea in 1998. Japan, once the world’s second largest economy, experienced a double crash. But now, could China be “turning Japanese”? The recent 14 percent decline of stock prices in Shanghai is quite worrying.

As with Japan’s, China’s economic downturn has been attributed to the US subprime mortgage crisis, originating from a housing market bubble. Claude Borio of the Bank for International Settlements is convinced that the crisis will be long and severe if its origin is in the property sector. The loan default was just 7 percent of the entirety of home loans, nonetheless the crisis exploded in 2008.

Japan is said to be a role model for China, despite the countries’ different political systems. Likewise, South Korea also follows Japan’s strategy. If South Korea has also fallen into crisis, will China share the same fate? One of the similarities of the three countries is the significant role played by the assets markets.

The International Monetary Fund (IMF) shows that within the period of 2004-2009, the price of houses in 35 cities doubled, while in 70 other cities the prices rose by 35 percent.

Between 2004 and 2007, house prices rose rapidly, prompting the government in 2007 to soothe it by credit restriction and an increase in the mortgage interest rate. Nonetheless, the growth of real estate loans in 2009 was again higher, increasing bank exposure to the property sector.

China had a high growth rate of 9.7 percent during the 30 years of its economic reform, enabling the country to catch up with advanced countries in a short time compared to their economic progress in the past. China’s growth rate of 7 percent in the first quarter of 2015 was quite high, and if stable will double its gross domestic product (GDP) over the next 10 years.

Real estate development in China followed a constitutional amendment in 1988. Comprehensive housing reform started in 1994 by allowing state employees to have full or partial property rights to their apartments.

In 1998, the socialist model of housing was completely abolished. Additionally, the real estate sector was turned into a new engine for economic growth. Then China’s central bank lowered the mortgage interest rate five times between 1998 and 2002. The year 2003 was a milestone for the decade with a booming real estate sector.

The crisis in the US erupted in 2008 and the world economy entered into a great recession. It caused a decline in China’s economic growth due to a significant drop in exports. The growth rate followed a volatile pattern, ranging between 15.2 percent in 1984 and 3.8 percent in 1990. The growth driver of China’s economy before 2003 was the non-property sector with an average growth rate of 10 percent. But now most of the discussions are concentrated on the real-estate sector.

Some indications are worrying, because the debt level in China stands at 282 percent of GDP. However, 180 percent of that figure is from the private sector. Before 2012, the private debt ratio was higher in the US, but now it is higher in China than in the US. The global debt situation is also a tormenting issue. Since 2007, global debt has increased by US$57 trillion, outpacing the global growth of GDP.

In China, household debt has risen from $1 trillion in 2007 to $3.8 trillion in 2014. Nearly half of China’s debt is related to real estate. China’s economy added $20.8 trillion of new debt since 2007, representing one third of global growth in debt. High private sector debt could reduce household expenditure, due to the deleveraging process, lowering potential aggregate consumption. The share of consumption is normally around 60 percent of GDP, while in China it is only between 35 and 40 percent.

Due to a recent continuous growth rate decline, the People’s Bank of China (PBOC) lowered interest rates four times between November 2014 and February 2015. The PBOC reduced the reserve requirement ratio as well as the interest rate in February 2015, each by 50 basis points.

The Agricultural Development Bank of China received a special reduction of four percentage points. Surprisingly, on June 26, the PBOC reduced the interest rate for the fifth time to 4.85 percent, as well as the reserve requirement ratio (RRR).

The appreciation of housing prices was enormous from 2003 to 2013. Similar to IMF, in the first-tier cities of Beijing, Shanghai, Guangzhou, and Shenzhen, housing prices grew at an annual rate of 13.1 percent. For the second-tier cities, an annual real growth rate was 10.5 percent, while for the third-tier cities the real growth rate was 7.9 percent. It was a massive wealth creation that was previously unthinkable for China.

The price per earning of China’s stocks is also too high, standing at 44 in Shanghai in March 2015. The house prices in the first-tier cities appreciated 3.5 times, in the second-tier cities 2.7 times and in the third-tier cities 2.1 times.

These growth rates surpassed the housing price appreciation during the US housing bubble in the 2000s and were comparable to the housing bubble of Japan in the 1980s. The media reported that the value of property in the greater Tokyo area in 1989 was equivalent to the entire property value in the US, beyond reasonable comprehension.

Expert opinions on the future of China’s economy are at odds with each other. Nonetheless, in many respects, the economic development of China’s economy is an imitation of Japan’s model, which in 1990 fell into a double crash. Analogically, there could be a potential crash in the Chinese asset market.

The important point is to prepare for the two potential events, crisis and no-crisis. The question is how prepared Indonesia is to face the potential crisis, which nobody knows when will happen.

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Japan is said to be a role model for China, despite the countries’ different political systems.

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