Visitors stroll through the Qinhuang Food Alley in Qinhuangdao, Hebei Province, on Aug. 5, 2023. Consumption in China has recovered since 2023. Photo: Chen Mirong/CSST

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Since the outbreak of the COVID-19 epidemic, impact on the asset side by the property market downturn and underperformance of the stock market have prompted adjustments to the balance sheets of the government, corporate, and household sectors of China’s real economy. This, to some extent, has dampened the expansion of overall demand and dragged down economic recovery. In this context, whether China is experiencing a balance sheet recession has become a topic of heated debate in international academia. Some scholars have compared contemporary China with Japan of the 1990s, predicting that China will probably repeat a Japanese-style balance sheet recession and slip into prolonged stagnation. 

The “balance sheet recession” theory was put forward by Japanese economist Richard Koo in the 1990s when he examined the recession triggered by an asset price bubble burst in Japan. Academically, the balance sheet recession is not a very rigorous concept, but its three features—asset shrinkage, debt contraction, and economic recession—are distinct. In this theory, the balance sheet is the main conduit, and debt contraction, as a consequence of the shift from “maximizing profits” to “minimizing debt or costs,” is the primary working mechanism. 

As the balance sheets of the economic sectors in China have shown no signs of real contraction, or negative debt growth, assets have been shrinking within a normal range, and the economy has demonstrated resilience and recovered, we maintain that China doesn’t have a balance sheet recession. 

Differences from Japan

First, from the asset side, the decline of asset prices in China remains within a normal range. During the post-epidemic economic recovery, asset prices indeed shifted downward, but the overall decrease was limited. In terms of housing, residential property sales prices entered negative territory in 70 large and medium-sized cities since the second quarter (Q2) of 2022, down 8.3% cumulatively by the end of 2023. Among other housing markets, first-tier city markets were more stable, while second- and third-tier cities experienced relatively sharp declines, down 6.6% and 10.8% cumulatively. In the stock market, from 2022 till now, the Shanghai Composite Index fell from the peak of over 3600, briefly dipping below 2700, and is back above 3000. Generally, these asset price fluctuations are normal, far from a plummet or collapse. 

By comparison, Japan suffered from a much more dire scenario. Starting from the 1990s, overly restrictive monetary and real estate policies led asset bubbles to pop, and the stock and property markets successively underwent drastic adjustments. 

In the stock market, the Nikkei 225 Index approached 39,000 in early 1900, but plummeted to a low of 14,000 in 1992, down 63% cumulatively. In April 2003, the index dropped below 8,000, hitting a record low. In 1989, the market value of Japanese listed companies totaled $4.3 trillion, but it shrunk to $2.9 trillion in 1990, a decline of 31.3% year-on-year. 

Within the real estate sector, Tokyo’s home price index took a dive from the peak of 248.3 in late 1990, down 24.7% within one year. The index fell below 100 in 2003 and then hovered around 100. Land prices continuously dropped from 1991 onward and didn’t resume positive growth until 2006. From 1991 to 2005, the decrease in land prices averaged 49.8%. 

On the debt side, debt continues to grow across the economic sectors in China, far from contraction. An important feature of a balance sheet recession is the private sectors’ shift from profit maximization to debt minimization, thus shrinking debt. In 1990 after the economic bubble burst in Japan, the private sectors’ balance sheet shrank dramatically, marked first by significantly slowing debt expansion, then 15 years of continued negative debt growth starting from 1998, followed by a turn toward positive growth in 2013. 

Specifically, debt growth in Japan’s household sector declined from 10.5% in 1990 to 1.2% in 1997. From 1998 to 2022, the household sector’s debt remained within the negative growth range, with annual debt growth averaging -1.35%. The corporate sector saw a debt growth slump from 11.3% in 1990 to zero in 1997, and negative growth since 1998. Positive growth didn’t occur until 2013. The average debt growth from 1998 to 2022 ran at -2.6%. 

In stark contrast, China’s household and corporate sectors have never experienced debt contraction despite a notable slowdown in debt expansion. By the end of 2023, debt of the two sectors grew 6.9% and 9.1% year-on-year, respectively. Although the rates were only half of the average growth over the past two decades, both sectors are still far from a recession. 

To be more specific, slight decrease of debt growth in the household sector and negative growth of some sub-items, such as home loans, in certain quarters are factual, but quick growth of personal business loans has contributed to the overall expansionary state of household debt, instead of negative growth. 

Since the 2015 Central Economic Work Conference proposed “deleveraging,” the corporate sector’s debt expansion has slowed down substantially, from 20.1% in Q1 of 2016 to 6.3% in Q4 of 2018. Although the ratio rose to around 10% later, there has never been real debt contraction.

When it comes to debt structure, debt of State-owned enterprises (SOEs), including local financing platforms, account for roughly 70% of corporate debt, while non-SOEs only take up around 30%. Although non-SOEs face higher risks of a balance sheet recession, the corporate sector hasn’t exhibited absolute contraction of existing debt, largely due to SOEs’ role as a stabilizer during the economic downturn. Particularly, financing platform companies have received implicit guarantees from local authorities and real financial support from the central government. This also differs fundamentally from Japan. 

In addition, debt expansion in China’s government sector is relatively evident. Since Q1 of 2020, the average quarterly growth of government debt hit 16.1%, almost doubling the private sector’s debt growth, effectively defusing balance sheet recession risks facing the private sector. 

In terms of economic growth, the Chinese economy has maintained strong resilience and rebounded. A balance sheet recession doesn’t merely involve balance sheet shrinkage. More importantly, the shrinkage might cause an economic recession. For example, subject to a balance sheet recession, Japan was mired in economic stagnation for 30 years. Since 1990, when the asset price bubble burst triggered a balance sheet recession, Japan’s economic growth stayed at around 1% for many years, leading to a declining share of the country in the global economy, from the peak of 17.9% in 1994 to 3.5% in 2023. 

By comparison, China has obviously grown faster than major developed economies in the world, serving as a key pillar of global economic recovery. In 2023, China’s GDP exceeded 126 trillion yuan, a year-on-year increase of 5.2%. The rate was 2.2 percentage points higher than that of 2022, further consolidating the positive growth trend of the Chinese economy. Moreover, China has contributed more than 30% to global growth for several years in a row, proving itself the largest engine of the world economy. 

The above analysis reveals that the so-called balance sheet recession, characterized by asset shrinkage, debt contraction, and economic recession, is not applicable to China. Falling asset prices have indeed shrunk assets, but an economic recession caused by debt contraction, the most important mechanism, doesn’t exist. In fact, debt is still expanding across the economic sectors and the Chinese economy still maintains relatively rapid growth. 

Signs of vitality 

Going further, the balance sheets of the three major economic sectors in China have exhibited new vitality, instead of recession. Signs of balance sheet expansion in the household, corporate, and government sectors, bolstered by development-oriented consumption, private investment, and the vitality of local governments, have presented themselves. 

First, household savings surplus has decreased, while development-oriented consumption has heated up. A balance sheet repair of the household sector has started, manifested in decreasing savings surplus and the gradual translation of deposits to consumption. 

In Q4 of 2023, the growth of China’s household savings cumulatively fell by 2.4 trillion yuan year-on-year, signaling weakening demand for precautionary savings. Boosted by effective policies to spur consumption, a steady increase in per capita disposable income, and robust demand for cultural consumption and tourism during the Mid-Autumn Festival and National Day holidays, residents’ precautionary savings, which accrued earlier, shored up a consumption recovery. In 2023, the total retail sales of consumer goods surpassed 47 trillion yuan, up 7.2% year-on-year. 

The uptick in development-oriented consumption has become a highlight of the consumption recovery. In recent years, survival-oriented consumption, primarily to meet daily needs, has decelerated amid stability, as consumption growth has been more driven by development-oriented consumption, such as healthcare, education, culture, entertainment, and services. Due to the scarring effect of the three-year COVID-19 epidemic, the demand for development-oriented consumption was temporarily inhibited, but it has recovered since 2023. In Q4 of 2023, per-capita spending for development-oriented consumption grew 16.4% among urban residents, nearly 10 percentage points quicker than survival-oriented consumption. 

Second, private investment has become more active. In 2023, private fixed-asset investment fell 0.4% from the previous year, yet it rose 9.2% year-on-year after the deduction of investment in real estate development. Private investment growth remains resilient. 

By industry, private investment in manufacturing remains vibrant, growing 9.4% year-on-year in 2023, 2.9 percentage points higher than overall investment in the industry. The growth has picked up for six consecutive months. 

In the fields of electrical machinery and equipment manufacturing, automobile manufacturing, as well as electricity, heat, gas, and water production and supply, private investment grew 30.1%, 18.0%, and 19.6% year-on-year, respectively, resulting mainly from the rapid development of lithium battery manufacturing, new-energy vehicles, and solar power generation. 

Increased vigor in private investment is mirrored by the improvement of the private economy’s prosperity level. Compared with the official purchase manager index (PMI) released by the National Bureau of Statistics, the statistical sample of the Caixin manufacturing PMI, which consists mostly of export-oriented small and medium-sized private enterprises in coastal areas, is more indicative of the private economy’s prosperity. In 2023, the Caixin manufacturing PMI bounced back to the expansionary range of above 50%, and was higher than the official PMI for most months of the year, suggesting relatively quick recovery in the production and operation of private manufacturing. 

Third, the central government has lent strong support for resolving debt, hence enhancing the vitality of local economy. Given that local governments were generally weighed down by debt and too swamped with debt repayment to develop the economy, the central authority offered real financial support for local governments to repair their balance sheets, which has greatly stimulated local economic development. 

On one hand, local governments re-issued special refinancing bonds to ease short-term debt pressure. In Q4 of 2023, they cumulatively issued 1.4 trillion yuan of special refinancing bonds to replace existing hidden debt and pay down debt to enterprises. 

On the other hand, the issuance of new special government bonds and budget deficit adjustments in late 2023 were significant moves. With the advantages of flexible issuance mechanisms, efficient approval processes, and the principle of using funds as earmarked, special government bonds are usually excluded from fiscal deficit. The newly issued special government bonds were all incorporated into central fiscal deficit, sending more positive fiscal policy signals that will accelerate economic recovery. Additionally, the principal and interest repayment of the new special government bonds was all born by the central authority, adding no debt pressure to local governments. They can use acquired funds for post-disaster reconstruction and infrastructure investment, thereby mitigating risks of local hidden debt. 

Zhang Xiaojing is a research fellow and director of the Institute of Finance and Banking at the Chinese Academy of Social Sciences. 

Edited by CHEN MIRONG