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China's Economic Predicament: Unprecedented Challenges Ahead



China is currently dealing with a serious economic crisis that has alarmed people both at home and abroad. This turbulence was sparked by the shocking failure of Evergrande, the top real estate developer in the country.


Evergrande's recent filing for bankruptcy protection in New York has rippled across the global financial landscape with liabilities reaching $300 billion and losses exceeding $80 billion over the previous two years. This turning point signals a crucial change in China's course and emphasises how unique the current economic crisis is compared to earlier difficulties the country has encountered.


For many years, China's real estate industry has supported the country's economic growth by significantly boosting its GDP. In contrast to earlier economic downturns, the current crisis is singular because of a complex interaction of causes. An important aspect is the cascade effect from the real estate industry to the financial industry, which heightens concerns about a more pervasive financial situation.


In contrast to previous instances, a sizable number of China's leading real estate developers are now mired in a debt-related morass. The complex relationship between these developers and the financial industry, particularly the wide availability of wealth management products from investment conglomerates, has made the problem worse. Financial instability is brought on when developers fail to repay their debts.


Naturally, comparisons to the 2008 collapse of Lehman Brothers are made. However, it is crucial to recognise that, despite similarities, China's predicament has distinctive features, as analysts claim. A complicated web of financial derivatives and risky lending practises led to the Lehman Brothers disaster. On the other hand, China's unrest is inextricably linked to the real estate sector, which holds a unique significance within its economic structure.


This problem has its origins in China's 2016 policy shift, which was summed up by President Xi Jinping's declaration that "housing is for living, not for speculation." The program, intended to deflate the real estate bubble, was designed to restrain speculative investment. Although the intention was to increase housing affordability for the general public, its effects have rippled across the economy in unexpected ways.


Following the financial crisis of 2008, government support for construction projects helped the real estate market evolve into a refuge for speculators. This trajectory led to an increase in residential units, which ironically occurred at the same time as a sharp fall in the number of first-time homebuyers. In response, the Chinese government tightened acquisition restrictions in key cities and reduced state-owned bank operations.


However, the COVID-19 pandemic's global effects hampered construction schedules, leading to delays and cost overruns. A significant number of unfinished projects created a perplexing situation. Notably, a sizable inventory of unfinished residential units was the sole responsibility of Evergrande. Even with government initiatives, the liquidity situation has been made worse by dwindling buyer confidence in the market.


The ability of this crisis to cause disruptions throughout China's trust business, acting as a shadow banking system that supports growth initiatives, is the core of its uniqueness. A risky environment results from the interdependence of these trusts and the real estate market. Investment funds are prevented from selling their shares if developers default on their payments, casting a shadow over the market.


China's economic health is heavily dependent on real estate development, which accounts for 30% of the country's GDP. Moreover, land deals with real estate developers provide for a sizeable portion of local governments' income. A delicate balance that was previously maintained by these developers' reliance on state banks and investment funds and their reliance on the sale of apartments to pay off debts has now been upset.

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