3 big problems vex China’s economy—and complicate Xi Jinping’s plans for a third term: ‘People in China are clearly unhappy with the state of the economy’

August 1, 2022, 9:51 AM UTC
A portrait of Chinese President Xi Jinping in Shanghai. Xi is facing economic challenges.
Qilai Shen—Bloomberg/Getty Images

Later this year, Chinese President Xi Jinping is set to assume an unprecedented third term in power, which will likely cement his reign as the most powerful Chinese leader since the country’s founder Mao Zedong. But before then, Xi has to deal with the most restive period on his watch, largely a result of self-inflicted economic wounds.

In recent weeks, thousands of people in central Henan province have protested at banks that have refused to give them back their deposits; tens of thousands of homebuyers across the country have boycotted the mortgage payments they owe on stalled housing projects; and people across the country have fled from COVID lockdowns. Combined, the social unrest amounts to the largest collective mobilization of disaffected Chinese citizens in years; individually, they each stem from one of Xi’s signature policies, blotting the president’s track record as he vies for another five years in power.

“People in China are clearly unhappy with the state of the economy,” says Steve Tsang, director of the SOAS China Institute at the University of London. “And many see the problems as driven by [the government’s] misguided policies.”

Last week, Xi stuck to his guns by not making any major changes at a Politburo meeting of China’s top leaders to set economic policy for the rest of the year. Xi’s decision to maintain his current economic policies is a risky bet, experts say. Until now, Xi has staked his legitimacy on delivering a GDP that grows year after year. Standing by policies that are hurting China’s economy and igniting social dissent may not deny him a third term, but they could dilute his mandate and make it harder for him to carry out his vision.

Property problems

For decades, Chinese citizens have snapped up homes as a means of investment. Storing their nest eggs in the country’s usually booming real estate sector is a far safer bet than chancing their fortunes in the country’s volatile stock market. Roughly 7% of Chinese citizens own stocks, compared to 56% in the United States. Chinese households, meanwhile, store 70% of their wealth in real estate, twice as much as Americans. Buying a home whose value seems destined to rise also helps compensate for the country’s weak social safety net. As a result, China’s insatiable demand for new housing projects has turbocharged the real estate sector, helping property developers sell towering blocks of apartments faster than they could build them.

But even in a country of 1.4 billion people, there is a limit to how many apartments people need. About one-fifth of Chinese homes—roughly 65 million units—stand empty, oversupply that resulted from a real estate market of distorted incentives. Developers, which rely on local banks for loans to build new projects, buy land for construction projects from local governments. Local governments, in turn, depend on those land sales (instead of property taxes) to make up 40% of their local budgets, making them eager to attract new housing projects even if their constituents have enough homes. That cozy triangle of banks, local governments, and property developers appeared to work well for everyone as long as real estate prices continued to rise. But then Xi decided to expose the market’s shaky foundations.

Xi has sought to tackle inequality and make houses more affordable by ending the practice of buyers snatching up homes as investment properties, and instead has promoted the principle that houses are for “living in, and not for speculation.” Evergrande, a property giant that built up a $300 billion debt load, became the prime example of Xi’s attempts to curtail the sector’s excesses.

Last year, Evergrande struggled to meet the Xi administration’s new “three red lines” rules that forced developers to limit their debt. The firm plunged into free fall while struggling to meet its debt obligations. Evergrande’s crisis contaminated other indebted developers, and China’s housing market suffered. The prices for new homes in China have fallen for 10 straight months, and analysts expect prices to keep dropping in coming months. In June, property investment and property sales fell 9.4% and 18.1% year on year, respectively.

Cracking down on debt-starved local governments and the local banks that finance them limits their most important source of revenue: new land sales. And the credit pullback has made it difficult for developers to find enough cash to finish projects, angering the buyers who are paying mortgages on still-unbuilt homes.

“The [mortgage boycotts] are a meaningful threat to the housing market because such a large proportion—over 80% in recent years—of housing sales take place before construction is complete, often in the very early stages of construction, leaving two to three years between purchase and completion,” says Logan Wright, director of China market research at Rhodium.

Last week, over 200 people swarmed a government office in Hubei chanting the slogans “Construction stops, mortgage stops!” and “Deliver homes and get repaid!”, according to the Wall Street Journal. The protest followed the boycotts of tens of thousands of Chinese homebuyers in at least 91 cities who withheld mortgage payments on homes in more than 300 stalled residential construction projects.

“It’s not actually that Chinese citizens are becoming bolder,” says Alfred Wu, a Chinese politics professor at the National University of Singapore. “Housing is just a life-or-death issue for Chinese families…they spend so much money on it.”

At least one Chinese city is establishing a bailout fund to quell the concerns of boycotters and ensure that property developers finish their projects. But experts say such measures may only provide a temporary reprieve.

“Bailing out the…developers can of course ease short-term stress. But it will not only waste money, it does nothing for the long-term problem,” says Derek Scissors, chief economist at China Beige Book. “China needs a broader, deeper set of investment options to keep people from becoming financially dependent on housing appreciation, or boycotts and the like will keep occurring.”

Bank protests

Xi’s property crackdown has also sparked another series of public protests.

In April, local authorities in central Henan province arrested the majority shareholder in several banks across Henan and neighboring Anhui province. Sun’s sudden arrest spooked customers at banks associated with him and triggered a bank run. The local banks halted customer withdrawals, prompting thousands of depositors to protest.

Chinese authorities pinned blame on a “criminal gang” that Sun was affiliated with, but experts say the problems run much deeper. Local banks have long been asked to issue risky loans to developers to fund new housing projects. But as the property crackdown has slowed construction activity, some property firms have been struggling to pay back their loans, squeezing banks.

SinoInsider, a U.S.-based risk consultancy, recently wrote that the Henan incident illustrated how local banks, compared to national ones, were particularly exposed amid China’s recent property crash, since property prices have fallen faster in rural areas than in urban centers. The bank depositor protests were just the “tip of the iceberg of serious systemic and financial risks with small- and medium-sized banks in China.”

Some depositors felt that the banking issues were not purely the result of isolated criminal acts, but rather a product of an economy in trouble. Chinese authorities said earlier this month they would pay some depositors back out of government coffers. But even some victims don’t believe the payments are a permanent fix.

“[The payments] don’t solve the underlying problem. It looks like Henan really has no money,” a bank depositor surnamed Hang recently told Hong Kong’s South China Morning Post.

COVID zero

The biggest drag on China’s economy this year, and the one policy that Xi may have the most direct control over, is COVID zero, says Wu.

China relies on strict lockdowns, mass testing, and mandatory quarantine for travelers to keep COVID cases at bay. The emergence of the highly transmissible Omicron variant this year pushed Beijing to double down on the policy.

In May and June, authorities locked millions of Shanghai residents in their apartments for weeks on end to contain China’s largest-ever outbreak, bringing economic activity to an abrupt halt. In the second quarter of this year, Shanghai’s economy shrank by 14% year on year, a $21 billion contraction in the city’s economy. That loss contributed to China’s worst quarter since the beginning of the pandemic. GDP fell 0.4% in the second quarter compared to the previous year.

During the lockdown, some residents stormed the streets to demand authorities bring food to their hungry neighbors. Thousands of people banged pots and pans outside their windows to call for an end to the lockdown. And millions spread videos criticizing the lockdown online. Despite public backlash, authorities refused to waver from the policy.

Due to the Omicron subvariant BA.5, cases are once again on the rise in China. But people are also finding new ways to resist the government’s policies. In recent days, people in places like Shenzhen have climbed fences and run away on foot to escape mandatory quarantines.

“There is clearly this growing unhappiness with the COVID-zero policy,” says Yanzhong Huang, senior fellow for global health at the Council on Foreign Relations. “We’ve seen this simmering social discontent. But so far it’s mainly confined to cities like Shanghai that were directly impacted by the policy and has not resulted in mass incidents or widespread violence against the government.”

Still, there’s a risk that China’s COVID-zero policy could backfire in coming months, Huang says, especially since the BA.5 subvariant is so transmissible it escapes traditional containment measures.

“There’s a chance that BA.5 may lead to nationwide outbreaks that would render the COVID-zero strategy useless,” says Huang. “The social economic cost may increase to a level that it’s not acceptable anymore to even Xi himself.”

Tsang says that Xi looks poised for a third term no matter what, but he may back off on COVID zero and the property crackdown to secure a greater mandate this year. If not, Xi may struggle to install loyalists to carry out his policies during a third term, the Wall Street Journal reports. China’s vice premier Li Keqiang and the pro-liberalization side of the Chinese government have gained power as China’s economy has lost its footing, and may challenge Xi’s singular dominance in a third term.

“Xi will settle for stability and some elements of growth to ease the pain on the people so there will be less unrest or protest against the economic situation this year,” says Tsang.

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