China's Economy on the Brink: Will Policy Shift Usher in a 'Lost Decade'?

The Chinese government has undertaken a policy shift for the first time in 14 years. At the "Central Economic Work Conference" held on December 11th and 12th, a policy was announced to shift monetary policy from neutral to easing in order to stimulate the economy. This marks a significant change, steering away from the long-standing policy of prioritizing production expansion towards one that emphasizes sluggish consumption. However, this policy shift could also suggest the severity of the problems facing the Chinese economy and the difficulty of its recovery.

A Policy Shift After 14 Years: The Underlying Sense of Crisis

In the Chinese mainland and Hong Kong stock markets, share prices temporarily rebounded due to expectations surrounding this policy shift. Expectations of stock price maintenance measures (PKO) by the government and the central bank (People's Bank of China) also fueled the rise in stock prices. However, long-term interest rates have fallen, and the decline in the yuan's exchange rate against the dollar is accelerating. This indicates that the market still harbors strong concerns about the future of the Chinese economy.

This policy shift is evidence that the Chinese government is increasingly concerned about the economic downturn. The slump in the real estate market is particularly serious. The real estate sector, which once accounted for about 30% of China's GDP, is now a drag on the economy. Local governments are attempting to revitalize the real estate market by purchasing excess apartment inventory, renovating it, and selling it at low prices to low-income households, but the effectiveness of this is uncertain.

The US Monetary Policy Shift and the Slowdown of the Chinese Economy

Furthermore, the environment surrounding the Chinese economy is becoming increasingly severe. Since 2014, the United States has shifted towards normalizing its monetary policy and begun raising interest rates. This means that excess investment funds that had flowed into emerging markets are flowing back out, significantly impacting the Chinese economy. In the 2013 "Bernanke Shock," the suggestion of a reduction in US quantitative easing caused significant turmoil in emerging markets, and emerging market currencies, including China's, fell sharply against the dollar.

The slowdown of the Chinese economy itself is also a source of concern for the market. In the second quarter of 2012, China's real GDP growth rate was 7.6%, the lowest level since the first quarter of 2009. This reflects not only sluggish demand but also a decline in potential growth rate due to changes on the supply side. In particular, the slowdown in real estate investment due to measures to curb the real estate bubble and the sluggish growth in exports due to the global economic slowdown have dealt a significant blow to the Chinese economy.

Is the Policy Shift the Beginning of a "Lost 30 Years"?

The Chinese government's policy shift under these circumstances has similarities to the Bank of Japan's monetary policy shift. On March 19, 2024, the Bank of Japan decided to lift its negative interest rate policy. This was because the realization of a 2% inflation target accompanied by wage increases became foreseeable. However, the Bank of Japan's policy shift overlaps with its history of economic slumps following interest rate hikes, forcing policy corrections. The interest rate hikes in 2000 and 2006 both necessitated policy corrections within a short period and were criticized as "premature judgments."

The Chinese government's policy shift also carries similar risks. A policy that relies on monetary easing and fiscal stimulus without concrete measures for demand creation may lead to a temporary economic recovery but is unlikely to lead to sustained growth. Instead, excessive liquidity supply increases the risk of creating new bubbles.

Furthermore, the Chinese government's strengthening control over the socio-economic sphere could accelerate the outflow of capital and talent overseas. If a Trump-like administration comes to power in the US after 2025, tighter policies against China are expected, creating further headwinds for the Chinese economy.

China's policy shift could mark the beginning of a "lost 30 years," similar to Japan's experience. After the collapse of the real estate bubble, Japan fell into a long-term economic slump due to delayed bad debt processing, prolonged deflation, and stagnation of structural reforms. The current Chinese economy faces similar problems to Japan at that time, such as a slump in the real estate market, excessive debt problems, and a decline in the working-age population.

How the Chinese government addresses these challenges and charts a course for sustainable growth is a question of its capabilities. This policy shift will be a major turning point for the future of the Chinese economy. The world is watching to see whether it will be simply a stimulus package or a true transformation involving structural reforms.