China’s Economy Faces Challenges
China, the world’s second-largest economy, is experiencing a downturn. For the first time since 2005, the country has seen a contraction in outstanding loans. This means that households and companies are paying off their debts instead of taking out new loans. This trend is worrying because it could lead to a self-fulfilling cycle of economic underperformance.
Weaker Loan Demand
The decline in loan demand is a negative sign for future growth, according to Lynn Song, chief Greater China economist at ING Bank. Song’s biggest concern is the entrenched pessimism among consumers and businesses, which is the main reason for weak borrowing appetite. The flow of credit will dictate the economic tempo for years to come, and Beijing is facing a challenge in lifting languishing domestic demand.
Balancing Act
Policymakers are trying to tackle price wars and reduce excessive competition without sparking job losses or further depressing consumer sentiment. This is a tricky balance, as reining in China’s overcapacity problem could have a negative impact on loan demand. State media reported that the effort to resolve hidden debt and ensure big companies pay their small suppliers on time may have also contributed to the poor borrowing demand.
Property Market Woes
The property market has deteriorated, weighing on household loans. Consumer subsidies have slowed temporarily, and companies are dialling back their borrowing due to intense price wars and US tariff threats. The only expansion in July was in bill financing, a tool used by banks to inflate lending when borrowing demand is weak.
Risks of a Japanese-Style Recession
While it may be too early to ring the alarm about the risk of a Japanese-style balance-sheet recession, there are concerns about the renewed weakness in the property market. Beijing will likely find boosting demand difficult without stabilizing the property market, which is a store for almost 60% of household wealth. The housing sector may not bottom out until mid-to-late 2026, according to some estimates.
Credit Growth
China’s credit growth has been stuck in a low gear since 2022, and not even interest rate cuts by the central bank have been able to reverse the slowdown in lending. Industrial loans skyrocketed after the pandemic, but their moderation in recent months shows that China’s manufacturing machine is also not immune to a feeble appetite for debt.
Deflation and Low Growth
As deflation becomes increasingly pervasive, it’s souring household and business expectations for future income and profit. The danger is that without a timely fix to reflate the economy, China may follow Japan’s footsteps and become trapped in decades of deflation and low growth.
Conclusion
In conclusion, China’s economy is facing significant challenges, including a contraction in outstanding loans, weaker loan demand, and a deteriorating property market. Policymakers are trying to balance the need to tackle price wars and reduce excessive competition with the risk of sparking job losses or further depressing consumer sentiment. The central bank is taking a targeted approach to credit support, shifting away from broad-based stimulus and focusing on key sectors such as tech and green industries. However, the risks of a Japanese-style recession and deflation are real, and it remains to be seen whether Beijing can successfully navigate these challenges and restore growth to the economy.
