In China, for example, banks are heavily exposed to the real-estate market. Roughly a quarter of assets held by banks are backed by property, Sufi observes. Municipal governments have piled on debt to invest in public infrastructure projects, and while defaults may be limited by the central government, any slow in spending will hurt the economy.
Real estate accounts for most of Chinese household wealth, linking consumer sentiment closely to the health of the housing market. Consumer spending is extremely sensitive to indebtedness.
“Households that borrow more in a given year typically see a reduction in consumption in the subsequent years, and this same relationship holds for regional areas that borrow more in a given year,” Sufi writes. “This is a worrisome pattern given the large rise in the household debt to income ratio across households.”
In South Korea, the bigger concern is a surge in interest rates: they almost tripled in a year and a half, from 1.25 percent in April 2022 to 3.5 percent in August 2023. More than 80 percent of household mortgages have floating rates, so higher borrowing costs are an ominous sign for consumer spending.
The final concern for both countries is the likelihood of slowing global growth. China and South Korea rely on exports, which will have to pick up the slack if domestic consumption and residential investment weaken.
Yet there are mitigating factors, Sufi suggests. Even if we assume slower growth ahead, global indebtedness is much lower now than it was on the eve of the 2008–09 financial crisis.
In addition, China and South Korea have maintained current account surpluses—more exports than imports—through the recent debt cycle. Countries with positive current accounts typically have less severe downturns following a boom.
Finally, both governments are ready and able to manage financial stress, Sufi observes. “In China, for example, all indications are that the government is willing to go to extreme lengths to prevent a major financial crisis from erupting,” he writes, noting that the same is true for policy makers in Korea, who “also garnered a strong response to the threat of a financial crisis in the latter half of 2022.”
Both countries bear watching, Sufi concludes, even if early indications are that the coming downturns won’t be as severe as past episodes.