China

Growth recovery to remain bumpy

China’s economic recovery from Covid was uneven and bumpy in 2023, and the growth momentum going into 2024 will remain difficult. The reopening boost to the Chinese economy has been weaker and shorter than expected, leading to an incomplete rebound. In 2023, the Chinese economy expanded 5.2%, slightly exceeding the official full-year growth target of “around 5%”. Economic expansion was mostly driven by total consumption (54% of GDP in 2022). Private and public consumption contributed over 80% of the GDP growth in 2023, followed by nearly 30% from investment (44% of GDP in 2022). Net exports were the main drag on GDP, in contrast to the previous years since 2019, and took 0.6 percentage points off the growth rate. This is because of a recovery in services imports (outbound tourism rebound) and weakened goods exports.

This fragile recovery attracted the attention of the Chinese leadership. Since August 2023, the authorities have announced a series of incremental policy support for the economy, covering a range of areas such as fiscal, monetary, housing, and equity markets. Growing concerns over the recovery momentum led the government to take an unexpected decision in October 2023 to issue 1 trillion yuan (0.8% of China’s GDP) in special central government bonds by the end of that year, which will raise the 2023 budget deficit to 3.8% of GDP, up from the implicit ceiling of 3%. China’s economic recovery is faced with insufficient domestic demand, which has not offset the drag from weak external demand. Part of the weakness in domestic demand stems from the housing market correction, which affects consumption, investment, job market and confidence. Job market conditions have deteriorated. Urban youth unemployment hit a record high of 21.3% in June 2023 before the release of this official data was suspended. After a methodology review, the resumption of the data release saw the youth jobless rate fell to 14.9% in December. Surveys from the central bank and National Bureau of Statistics have reflected weak job prospects and weak confidence. This has affected consumption. Retail sales rose 7.2% y/y in 2023, below the pre-pandemic average of 9.5%. With 70% of China’s household wealth being held in real estate, the ongoing real estate crisis will continue to dent consumer confidence and erode purchasing power for several years. Real estate and related industries generated around 30% of GDP. Real estate investment and sales continued to decline throughout 2023 as developers grappled with high debt, payment defaults and dwindling home sales (especially in lower-tier cities). This led to the authorities stepping up support for the ailing sector from mid-2023 after unveiling a comprehensive rescue plan in November 2022. Bloomberg reported that the People’s Bank of China (PBOC) plans to provide at least 1 trillion yuan of low-cost financing through the policy banks to boost the housing market. In December 2023, the PBOC made 350 billion yuan available in loans through its Pledged Supplementary Lending (PSL) facility to the three policy banks (China Development Bank, Export-Import Bank of China and Agricultural Development Bank of China). The central government is also reportedly working on a draft list of 50 developers eligible for bank financing support.

The underlying problem for Chinese economic development is structural. China is going through a secular deleveraging of its economy. It has been far too dependent on debt to drive growth, especially in real estate. Debt of the non-financial sector (households, government, non-financial corporates) ballooned from 139% of GDP in 2008 to 313% as of Q3 2023. China has been trying to transition from investment into more sustainable forms of growth, including consumption and higher added-value manufacturing. The move gained greater urgency in recent years amid an ageing population and rapidly diminishing returns from capital accumulation.

Shift in central-local fiscal imbalances

China approved a 1 trillion yuan increase in its 2023 fiscal deficit, effectively raising from an implicit ceiling of 3% of GDP to 3.8%. The increase in the fiscal deficit through the issuance of central government bonds is unusual because it has only happened three times over the past 25 years (1998, 2007, 2020), and under major crises or to accomplish major policy goals. The proceeds of these additional 1-trillion yuan central government bonds will be transferred to local governments (500 billion yuan each in 2023 and 2024) for spending in the rebuilding of disaster-hit areas and improving disaster relief capacity. This policy move is consistent with the government’s priority task to address local government debt problems. From a reform perspective, it is also an early step to tackle the imbalance between local governments’ spending responsibilities and their revenue allocation. In 2022, local governments spent 86% of total expenditure but only collected 53% of total fiscal revenue, reflecting their sustained and growing fiscal deficits that have prevailed since the 1994 fiscal reform.

The fiscal situation of local governments has deteriorated due to an evaporation of non-budgetary financing sources, especially land sales and local government financing vehicle (LGFV) borrowing. Local governments have amassed “hidden debt” (or off-budgetary borrowing) estimated by the IMF to be as much as over half of China’s annual GDP. The “hidden debt” problem of local governments is a major source of concern for the Chinese leadership, and a policy priority.

The current account surplus has narrowed in 2023. Weaker goods exports resulted in a smaller trade surplus. This narrowing of the trade surplus was amplified by the services deficit which widened to near pre-Covid level, aided by reopening borders and the tourism recovery. The larger current account surpluses over the pandemic years (2020-2022) were likely one-off, and unlikely to repeat due to secular factors. Current account is a function of the difference between national savings and investment. With national savings expected to return to its long-term declining trend amid an ageing society, the current account balance should remain close to zero in the coming years. Meanwhile, China also recorded its first-ever deficit in net foreign direct investment in the third quarter of 2023, according to balance of payments data. This reflected capital outflows pressure amid de-risking moves after foreign firms repatriated profits due to more attractive interest rates elsewhere. Consequently, the yuan depreciated in early September to its weakest level since 2007.

Renewed anti-corruption campaign

Xi Jinping secured a norm-breaking third term as General Secretary of the Communist Party of China (CPC) in October 2022, with the politburo standing committee, the highest decision-making body of the CPC, endorsing four newcomers (Premier Li Qiang, Cai Qi, Ding Xuexiang and Li Xi), all known to be allies of Xi. Additionally, Shanghai Party Chief Li Qiang became the Premier after the annual session of the NPC in March 2023. The outcome of the 20th Party Congress highlighted Xi’s prevailing dominance within the Party, suggesting that recent troubles, including economic woes, discontent with the zero-Covid policy, and increasingly strained relationships with Western advanced economies, failed to loosen his grip on power. There was no mention of a designated successor, which hints at the possibility of Xi holding on to power beyond a third term. Xi has also vowed to step up a crackdown on corruption in key sectors, which includes finance, energy, and infrastructure, as well as the military.

The recent sackings of some of China’s top officials, including foreign minister Qin Gang and defence minister Li Shangfu, reflected the current diplomatic and military leadership shifts. China’s military recently saw several high-level officials and generals removed from their posts, such as Commander of the Strategic Support Force General Ju Qiansheng, PLA Rocket Force commander General Li Yuchao and deputy General Liu Guangbin. The deepening purge, however, could be seen as an important step to secure the reliability of the military in preparing China for modern-day warfare.

Payment

Cash payment is usually used for face-to-face domestic retail transactions. Due to tight capital controls imposed by the authority, an individual can only purchase up to USD 50,000 each year. Furthermore, when a Chinese company makes an international payment in a foreign currency, the company must submit a foreign currency payment application with the local bank, along with supporting documents like sales contracts and invoices. The whole process can be quite lengthy and it is possible that the bank will reject the transaction.

Commercial Acceptance Drafts (CAD) and Bank Acceptance Drafts (BAD) are both common methods of payment for Chinese companies. These are two negotiable instruments: whereas CAD is issued by companies to entrust the payer to unconditionally pay the specified amount to the beneficiary on the date, BAD is issued by the acceptance applicant, entrusting the acceptance bank to make unconditional payment of a certain amount of money to the payee or bearer on the designated date. In practice, BAD is regarded as safer and therefore more accepted than CAD.

Letter of credit and cheques are also used, but are less popular in China. The use of letters of credit is typically confined to big companies; and cheques are used infrequently by both individuals and companies.

SWIFT bank transfers are also among the most popular means of payment as they are rapid, secure, and supported by a developed banking network, both internationally and domestically.

Debt Collection

Amicable phase

The creditor makes phone calls and sends letters of collection to chase the debtor for payment. If debtor is responsive and acknowledges the debt, the two parties will negotiate payment plans to try to have payment settled. In the existence of a dispute, both parties need to come to an agreement or offer discount on debt amount.

Legal proceedings

The Chinese court system is complex. It is divided into multiple tribunals at different levels. The basic People’s Courts are at the lowest level with the County People’s Courts or Municipal People’s Courts. The basic People’s Courts have jurisdictions over most cases of first instance. Intermediate People’s Courts handle certain cases in first instance, such as major foreign-related cases, as well as appeal proceedings brought against decisions rendered by the basic People’s Courts. At the Higher level, the High People’s Courts decide on major cases in first instance. The Supreme People’s Court is at the highest level, which handles interpretation issues, and has jurisdiction over cases that have a major impact nationwide.

Fast-Track Procedure

If the debt is purely monetary, there are no other debt disputes between the creditor and the debtor, and the repayment order can be served on the?debtor, the creditor can apply for a repayment order against debtor with the court. The debtor has 15 days to repay the debt after the order is issued; otherwise, he must submit a defence before the payment deadline. If debtor fails to do either, the creditor can apply for enforcement. However, if debtor’s written defence or objection is approved by the court and the ruling for terminating the debt payment order is issued, the debt payment order will be invalidated and the creditor can choose to pursue legal action. In practice, creditors do not usually use the fast-track procedure and will immediately initiate legal proceedings when the amicable phase fails.

Ordinary Procedure

Legal proceedings commence with the creditor lodging the case and submitting statement of claims with the court with corresponding jurisdiction. Once the case is accepted, court summons will be delivered to parties involved. Usually within one month, the first hearing will be arranged and the court will make a final attempt to reach a payment agreement between creditor and debtor via mediation. If no agreement can be reached, the litigation continues with several rounds of hearings, before a judgement is rendered by the court.

In theory, a first instance ruling could be rendered within six months after the case’s acceptance, but in practice, proceedings can last longer as the complexity of the case increases (for example, when there is more than one creditor, or when a foreign party is involved). In some cases, the whole process can last to one to two years. Furthermore, appeal proceedings must be terminated within three months after appeal acceptance.

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Enforcement of a Legal Decision

Domestic judgments, once obtained, can be executed by, for example, seizing the debtor’s bank accounts, property, or by a transfer of rights. The creditor can apply for enforcement with the People’s Court or with an enforcement officer.

For foreign judgments, the recognition and enforcement is based on the provisions of an international treaty concluded or acceded to by both China and the foreign country or under the principle of reciprocity. In practice, enforcing foreign arbitral awards is easier than enforcing foreign court decisions in China, because over 150 countries including China have signed and ratified the United Nations Convention on the Recognition and Enforcement of Foreign Arbitral Awards (New York, June 10, 1958).

Another method of enforcement is the “Arrange­ment on Reciprocal Recognition and Enforcement of judgments in Civil and Commercial Matters” (REJA) between China and Hong Kong. There are similar arrangements between mainland China and Macao, as well as between mainland China and Taiwan. It provides a legal basis for Chinese courts to enforcement judgments from Hong Kong, Macao, and Taiwan. It allows creditors to use courts from Hong Kong, Macao, and Taiwan for cases in mainland China.

Insolvency Proceedings

Parties may agree debt restructuring arrangements without going to court. However, such arrangements must not jeopardize the interests of any other creditors – otherwise, they may subsequently be declared invalid in any court bankruptcy proceedings.

The 2007 Chinese enterprise bankruptcy law sets out three types of formal bankruptcy proceedings: bankruptcy, reorganization and reconciliation.

RESTRUCTURING PROCEEDINGS

This can prevent a company with plentiful assets while experiencing cash flow difficulties from entering bankruptcy. Either debtor or creditor can apply with the court for Restructuring, which allows debtor to manage its properties under an administrator’s supervision. A restructuring plan should be approved by a majority of creditors in each voting class (secured, creditors, employees…) at creditor’s meetings, then sent to the court for approval within ten days from the date of?adoption.

After the implementation of the restructuring plan, the administrator will supervise and submit report on debtor’s performance with the court. The administrator or debtor must file an application to the court for approval within ten days from the date of?adoption.

RECONCILIATION

This procedure allows the company to settle its liabilities with its creditor prior to the court declaration of debtor’s bankruptcy. The debtor directly submits a payment proposal to the court and upon receiving court’s approval on compromise payment proposal, the debtor will recover its properties and business from the administrators. The administrator will supervise debtor’s performance and report to the court. If the debtor fails to implement the compromise proposal, the court will terminate this procedure and declare debtor bankrupt as requested by the creditors.

BANKRUPTCY

The procedure has the purpose to liquidate an insolvent company and distribute its assets to its creditors. The bankruptcy request should be applied with the court and the request can be sent both in the name of debtor and a creditor. Once accepting the bankruptcy petition, the court will appoint an administrator from the liquidation committee and debtor will be notified within five days and is required to submit financial statement to court within 15 days. The administrator will verify the claims and distribute the assets to creditors. After the final distribution is completed, the court will receive administrator’s report and decide whether to conclude the proceedings within 15 days.

SPECIAL PROVISIONS REGARDING ENTERPRISE BANKRUPTCY PROCEEDINGS DURING THE 2020 COVID-19 PANDEMIC:

In the event of creditors applying for a company’s bankruptcy proceedings due to debtor’s debt payment default as a result of the pandemic or pandemic prevention measures, the people’s court should endeavour to prevent debtor’s bankruptcy by actively facilitating debt negotiation between debtor and creditor with measures such as payment instalments, extension of credit terms, revising the contract prices.

The court should distinguish the companies under financial distress mainly due to COVID-19 from the ones already suffering from financial difficulties prior to the pandemic. For the former, the bankruptcy proceeding shall be prevented, while for the latter, the court shall let them go bankrupt.

Last updated: December 2023