How China plans to avoid a Japanese-style balance sheet recession
And why monetary policy can't rescue the Chinese property market.
China’s top policymakers and pundits have expressed concern over the possibility of the economy slipping into a Japanese-style balance sheet recession that could capsize growth for decades, given the dismal condition of the housing market and domestic credit growth.
They hope to use a boom in Chinese tech stocks, the state-driven diversification of household balance sheets and the “structural optimisation” of fiscal policy to avert this fate, given the limited efficacy of monetary policy as well as the potential for a protracted housing slump.
In this briefing:
Chinese credit growth and consumption still struggle
Housing slumps and balance sheet recessions
Restoring the wealth of Chinese households
Can China’s property slump be cured?
Why monetary policy will be of limited effect
Cutting interest rates poses a peril to the banks
The AI-driven restructuring of Chinese household wealth
Sovereign wealth stock manipulation
The structural optimisation of China’s fiscal stimulus
Chinese credit growth and consumption still struggle
The latest raft of data from China points to a plunge in credit levels in tandem with ailing consumption growth, despite Beijing’s launch of expansionary fiscal and monetary policy since the start of Donald Trump’s second term as US president.
Aggregate financing - a broad measure of credit extension in China’s economy, came in at under 630 billion yuan (US$93 billion) for April, according to a Bloomberg report based on data from the Chinese central bank.
This was little more than half the print of 1.2 trillion yuan for the same period last year, as well as under half the median forecast of 1.3 trillion yuan based on a Bloomberg survey of economists.
China’s household debt also dropped by 786.9 billion yuan (USD$115.6 billion) in April, for the largest contraction on record, while retail sales grew just 0.2% in year-on-year terms, for its dimmest print since December 2022.
The startling figures arrive amidst a multi-year campaign by Beijing to boost domestic demand, with an especial focus on consumer spending by Chinese households - on top of the adoption of expansionary macroeconomic settings.
At the end of 2024, China made “boosting domestic demand and spurring consumption” its top priority, in response to Donald Trump’s second-term presidential election win.
The limited impact of subsequent efforts to boost credit and spending highlight the potential for China to succumb to a balance sheet recession, thwarting Beijing’s efforts to keep the economy afloat via monetary and fiscal policy.
Housing slumps and balance sheet recessions
A “balance sheet recession” refers to a recession resulting from the bursting of an asset bubble, under conditions where the private sector of an economy bears inordinately high levels of debt.
The fall in asset prices can cause these heavily indebted households and businesses to become insolvent, forcing them to focus on paying off their debts and dial back on spending and investment, which in turn stifles economic activity.
The concept was devised by Richard Koo, chief economist at the Nomura Research institute, to describe the “Great Recession” that consumed Japan throughout the 1990s.
In recent years, economists from both China and abroad have expressed concern that the Chinese economy could follow the lead of Japan in succumbing to its own balance sheet recession, as a result of the housing market slump which commenced towards the end of 2021.
At the Fifth Bund Financial Summit, jointly hosted in Shanghai by the China Finance 40 Forum and the China Center for International Economic Exchanges in September 2023, Richard Koo himself said that China could experience a balance sheet recession due to households saving instead of borrowing.
Koo called for Beijing to accelerate the introduction of fiscal stimulus policies in order to rescue the market and prevent China from succumbing to the same fate as Japan.
Leading members of Chinese officialdom, such Qiu Baoxing (仇保兴), the former deputy-head of the Ministry of Housing and Urban-Rural Development (MOHURD) have also expressed concern about China’s vulnerability to a balance sheet recession.
“A household’s ability to consume is mainly determined by two factors - the first is how many assets the household has, and the second is its expectations of future incomes,” Qiu said in a speech delivered last December.
“The slide in real estate has led to a contraction in the assets of households, while also weakening people’s confidence in future earnings, thus suppressing consumption.”
Yin Jianfeng (殷剑峰), an economist from the Shanghai Institution for Finance & Development, has highlighted the impact of this wealth contractions on credit growth and consumption, under the conditions described by Koo.
“During the period from 2020 to 2025, households have deleveraged, as have local government financing vehicles, as a result of adjustments to the real estate market,” Yin wrote in the paper “Searching for Investment Opportunities in a Time of Low Interest Rates” (“殷剑峰：在低利率时代寻找投资机遇”) published last September.
“We can see from [2025] data that consumer loans and business loans to the household sector have both experienced significant negative growth, while medium- and long-term loans to the corporate sector have also seen negative growth.”
The vulnerability of China to a balance sheet recession arising from real estate slump could be particularly heightened by the fact that property continues to comprise such a sizeable chunk of Chinese household wealth.
According to official data, as of 2024 the property holdings of Chinese households stood at 395.6 trillion yuan - well over half their total asset holdings of 763.7 trillion yuan.
FT cites data from the Chinese central bank indicating that property comprises around 70% of China’s private wealth, with the average household owning 1.5 properties.
A key reason for predominance of property in household wealth is that even as China’s tech and manufacturing sectors have surged ahead, the maturity of its financial markets has lagged by comparison, leaving domestic retail and institutional investors with a dearth of reliable asset options.
Restoring the wealth of Chinese households
Given concerns over China’s vulnerability to a balance sheet recession, Beijing has made the recovery of the housing market - as well as boosting the health of domestic asset markets in general - one of its top economic priorities.
In March 2025, China incorporated the phrase “stabilising the property and stock markets” for the first time in history in the list of missions outlined by the Government Work Report, customarily unveiled at the start of the annual Two Sessions congressional event.
The goal of policymakers is to achieve wealth effects by reversing the property slump and buoying asset markets. They hope that this will in turn restore urgently needed domestic demand, via the healing effects of a recovery in asset prices on the damaged balance sheets of households and businesses.
Former deputy-head of MOHURD Qiu Baoxing has highlighted the importance of rescuing the property market when it comes to boosting consumption.
“The relationship between real estate and consumption is very clear,” Qiu said in a speech delivered at the Hexun Finance China 2025 Annual Conference in December.
“It is only by stabilising asset values and market expectations that we will be able to truly consolidate the foundations for consumption.”
Can China’s property slump be cured?
A number of leading Chinese commentators have highlighted, however, the huge challenges facing Beijing’s quest for stabilisation of the property market with the goal of achieving wealth effects.
They point to the existence of structural factors that could see the slump worsen in the near-term, or even become an interminable problem.
At present the crux of the issue remains deflationary pressure in the Chinese economy - which many argue is the product of the breakneck development of manufacturing and industrial capacity throughout Xi Jinping’s term in office.
Beijing is heavily preoccupied with addressing this issue, resorting to landmark policy campaigns such as “Anti-Involution,” which seeks to curb excess capacity and cutthroat price competition in key industries.
Zhang Bin (张斌), a researcher from the China Finance 40 Forum and the Chinese Academy of Social Sciences, said a chief reason that recent efforts to prop up the housing market have floundered is because of this unresolved deflationary pressure.
“In recent years China has implemented a series of property market control measures, but these have yet to succeed in stymieing the decline in home prices” Zhang said in April at a CF40 event.
“To stabilize future housing price expectations at a reasonable level, the prerequisites are stable growth in employment and income, increases in housing rents, and CPI growth remaining within a reasonable range of around 2%.”
The rule of thumb for central banks in general is to keep inflation at a rate of between 2 - 3%, as a safe compromise between employment-generating growth and gains in prices. China’s CPI growth has struggled, however, to keep its head above the 1% threshold since the start of 2023.
Another key factor which could prolong China’s property slump , and by extension the conditions for a balance sheet recession, lies in the unfavourable demographic changes that appear all but inexorable for modern economies.
China is already seeing a contraction in its population - a process which will eventually translate into reduced nationwide demand for dwellings if it continues unabated.
“Currently, there are 60 million housing units under construction, but due to negative population growth, only about 4 million new urban households are added each year,” Yin Jianfeng writes. “It will take more than a decade to clear the housing market.”
Other domestic observers are similarly pessimistic, such as Zhu Ning (朱宁), professor of finance at Shanghai Jiaotong University and author of the 2016 book “Rigid Bubble” (刚性泡沫) on overheating in China’s asset markets.
In August last year, Zhu predicted that housing prices could fall a further 20 - 30%, given the bubble in China’s property market prior to the 2021 slump.
Why monetary policy will be of limited effect
When it comes to policy measures for driving a recovery in the property market - as well as asset markets in general, monetary policy, in the form of cuts by the Chinese central bank to interest rates, is the obvious first port of recourse.
This reduces the cost of borrowing to support various forms of investment - whether that be for stock buybacks or housing and equipment purchases, which raises demand for assets and lifts their prices.
It also increases the valuation of assets whose present value is calculated on the basis of their expected future cash flows - such as stocks and rental property. This is because a reduction in interests also reduces the discount rate used to calculate their present values, which pushes the prices of such assets higher.
In China’s current situation, however, across-the-board interest rate cuts could be of little avail when it comes to buoying asset markets, or even boosting economic activity in general.
This is because under the conditions of a balance sheet recession, households and businesses will refuse to borrow irrespective of how cheap the cost of funding becomes, given that they are too busy deleveraging and attempting to recover lost value.
Cutting interest rates poses a peril to the banks
Another problem with the use of monetary policy by Beijing at present is that further rate cuts could pose a peril to Chinese banks. This is because Chinese interest rates are already at very low levels, sapping the profits of lenders by squeezing their net interest margins.
China’s main short-term policy rate - the central bank’s seven-day reverse repo, currently sits at just 1.4%, following the last cut implemented in May 2025.
This has put the net interest margins of China’s commercial banks under heavy pressure, which in turn saps their profitability at a time when the health of the sector as a whole is in doubt.
A key concern amongst domestic observers is that Chinese banks could be losing profitable lending opportunities, as well as seeing their non-performing loans (NPL) rise, due to the disintermediation arising from Xi Jinping’s push for the growth of direct financing via the capital market.
The net interest margin is the difference between the interest that a bank makes on the loans it extends to clients, minus the interest that it pays on deposits or other forms of funding.
It’s a key measure of the earnings power of banks, and when squeezed points to an erosion of profitability.
Yin Jianfeng has issued a stark warning of the impact that rate cuts by the central bank could have on the net interest margins of Chinese banks, and thus their overall health.
“The net interest margin of the banking sector has been declining continuously,” he writes.
“Currently, the net interest margin of large state-owned banks and city commercial banks has fallen to around 1.4%, while joint-stock banks are slightly better, at around 1.5%.
“It is generally believed that a net interest margin of 1.5% poses a significant challenge to the survival of banks.
“Under current circumstances, if interest rates continue to be lowered, the banks’ interest margins will be affected.”
The AI-driven restructuring of Chinese household wealth
Top Chinese policymakers still remain hopeful that Beijing can use wealth effects to help avert a balance sheet recession, despite the prospect of long-term enervation of the housing market and the limited efficacy of monetary policy measures.
They believe that they can achieve wealth effects via the diversification of household balance sheets into financial assets, reducing the predominance of property holdings while enabling them to capitalise upon the rise of the Chinese tech sector.
It would mean that Chinese households would be far less vulnerable to the weakness of the real estate market, yet give them greater opportunity to enrich themselves from the dividend payments and capital gains of rising stocks.
The plan dovetails with Xi Jinping’s current campaign to drive the expansion of capital markets in the Chinese economy, as part of efforts to more effectively and safely channel funds to domestic tech innovation via direct financing.
Such policy support also makes it an opportune period for Chinese equities investment, with senior officials expecting companies in tech sectors such as AI to post especially strong growth.
Wang Zhongmin (王忠民), the former deputy chair of China’s National Council for Social Security Fund is a vocal advocate for the restructuring of household balance sheets as a means of restoring their health, with an especial focus on tech investment.
“Policy makers have sounded the clarion call for the restoration of household balance sheets,” Wang said during a speech delivered last December at a Shanghai Stock Exchange event on high-quality development.
“The upcoming 15th Five-Year Plan period will be a crucial stage for repairing balance sheets and embracing new forms of wealth represented by AI-related assets.”
Wang argues that the Chinese government needs to adopt measures to drive households to expand their exposure to domestic equities, in order to both support the funding of tech companies as well as compensate for the lacklustre state of other investment options.
“Firstly, the risk-free rate of return has trended downwards, making the traditional model of wealth appreciation via dependence on deposit interest unsustainable,” he said.
“Secondly, real estate assets, a major component of household wealth, have entered an adjustment cycle, putting pressure on the overall health of their balance sheets.
“In the past, approximately 70% of household assets were allocated to real estate, with the dual leverage of households and developers forming the main body of debt.”
Sovereign wealth stock manipulation
The equities market is also subject to the restricted efficacy of Chinese monetary policy at present, as outlined above.
Unlike the property market, however, Chinese policymakers retain the ability to readily interfere with stock prices via purchases by state-owned investors and sovereign wealth funds - a move accommodated ideologically by China’s state-capitalist model.
Such interventions by the state have the ability to shift prices across the board, given that stock exchanges are accessible to investors throughout China and marginal buyers can move prices for the entire market.
A recent example is Beijing ordering Central Huijin to buy up A-share ETF’s in April 2025 in the week following the launch of Trump’s Liberation Day tariffs. Central Huijin - a wholly owned subsidiary of the sovereign wealth fund China Investment Corporation (CIC), also signalled that it would continue to make such purchases to serve as a “stabilisation fund” for the Chinese stock market.
The potency of such measures stands in stark contrast to housing markets, which are highly fragmented and consist of myriad regional sub-markets. In China’s case, the housing market is subject to an increasing “K-shaped” divergence, with first-tier cities and provincial capitals outperforming smaller urban centres.
In practice, this means that if policymakers order local governments or state-owned enterprises to buy up idle housing stocks, the impacts will only affect regional markets, and thus be of limited effect compared to nationwide impact of share purchases by state-owned investors.
The structural optimisation of China’s fiscal stimulus
The chief means for China to overcome the threat of a balance sheet recession will nonetheless remain Beijing’s continued adoption of expansionary fiscal policy - particularly given the complications involved in the diversification of household wealth, as well as the limitations of monetary policy and the potentially protracted nature of the housing slump.
The goal of policymakers will not only be for public expenditures to provide demand support - it will also be to achieve a transition in China’s development model that can enable the economy to achieve more sustainable development.
Zhu Baoliang (祝宝良), former chief economist at the State Information Centre, has said that China needs to “maintain the strength of expansionary fiscal policy,” or else risk “falling into a prolonged slump like Japan during its balance sheet recession of the 1990s.”
Chinese fiscal policy will focus on “structural optimisation” that can boost domestic consumption, via public spending that strengthens the social safety net and improves living standards.
Li Xunlei (李迅雷), chief economist at Zhongtai International and deputy-chair of the China Chief Economist Forum, said in an April interview with Securities Journal that fiscal policy will play a primary role in driving the transition in China’s development model, from an economy fuelled by investment and exports to one driven more by consumption.
He highlights in particular the focus given in this year’s Government Work Report to raising household incomes, strengthening healthcare, aged care and childcare, as well as the launch of a 100 billion yuan fund to promote domestic demand via the enhanced coordination of fiscal and financial policy.
These measures arrive on top of China’s existing subsidies for the purchase of consumer durables, such as EVs and white goods, via its “cash-for-clunkers” program. Chinese policymakers are now expected to further expand the initiative to include services consumption, as well as a broader range of consumer products.