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China’s economic slowdown can be attributed to the real estate market downturn and its impact on local government finances and debt. Over the past two decades, a significant portion of Chinese household wealth was invested in real estate, but with Beijing’s crackdown on debt reliance by developers in 2020, property values have been declining. This has led to a decrease in local government revenue, particularly at the district and county levels. S&P Global Ratings analysts predict that it will take three to five years for local government finances to recover. However, the continued rise in debt could prolong stabilization efforts.

The drop in land sales revenue and tax cuts since 2018 have affected the financial accounts of local governments, leading to a decrease in operating revenue and putting pressure on businesses. Officials are now scrutinizing businesses for potential tax evasion, with many companies receiving notices to repay taxes dating back to the 1990s. This has caused unrest among businesses and impacted business confidence.

Efforts to boost revenue include diversifying revenue streams and recouping taxes from past years. However, the emphasis on reducing debt levels and shifting towards consumption-driven growth has been challenging. Analysts warn that delaying this pivot could lead to Inflation and property price concerns. The ongoing focus on investment has resulted in weak GDP growth and a rise in debt-to-GDP ratios.

The complex network of local government-affiliated business entities, known as local government financing vehicles, poses a significant risk to banks. These entities have accumulated high levels of debt to fund public infrastructure projects with limited financial returns. Resolving these issues quickly remains a challenge, as the government aims to buy time to address liquidity challenges while maintaining stability in the financial system.

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