• The net worth of Chinese households has increased tremendously over the past two decades, driven by a high savings rate and rising asset prices.
• Real estate is the single largest component of the Chinese household balance sheet. The strength of that balance sheet depends on residential housing prices remaining high.
• A real estate correction would have significant impacts on household assets, net worth, and income.

The household balance sheet is critically important to the health of the Chinese economy. Economic reforms over the past several decades have led to immense wealth creation for Chinese households, particularly in the form of real estate. This new wealth has bolstered demand and raised living standards. Concerns are growing, however, that household net worth may be dependent on unsustainably high home prices.

Prevailing Winds is a China-focused blog written by Nicholas Borst, Director of China Research at Seafarer. The blog tracks the economic and financial developments shaping the world’s largest emerging market.

This Prevailing Winds post analyzes China’s household balance sheet and the sources of income that flow into it. It evaluates the interdependencies between the household, corporate, government, and financial sector balance sheets and analyzes the impact of a theoretical housing market correction on the household balance sheet. The analysis provides insights into the underlying risks and resiliencies in the Chinese economy.

Understanding the Household Balance Sheet

Assets

Households represent the largest concentration of wealth on China’s national balance sheet. They own the majority of China’s real estate and corporate assets. Figure 1 shows the distribution of the assets of Chinese households.

The household balance sheet is divided between non-financial (fixed) and financial assets. Residential real estate is the largest component of fixed assets. Other fixed assets include automobiles and farming equipment.

Since its establishment, in the late 1990s, China’s private housing market has grown into one of the largest asset classes in the world, as measured by value. Its housing stock is worth more than twice its gross domestic product (GDP). At the end of 2019, the value of real estate held by Chinese households (33 trillion USD) was larger than that of the United States (30 trillion USD).² In 2020 and 2021, however, U.S. housing prices continued to soar; Chinese home prices increased more moderately.

Financial assets are the other major component of household assets. Chinese households hold significant bank deposits, equity, insurance plan assets, and investment fund assets.

Compared with the U.S., household financial assets in China are skewed toward deposits, reflecting the facts that its equity markets are less developed and a significant portion of corporate equity in China is state owned. Financial assets represent a relatively small portion of household balance sheets in China relative to the U.S., a reflection of the outsized role of real estate as the primary asset of Chinese households.

Liabilities and Net Worth

In 2019, Chinese households held about 9 trillion USD of loans from banks and about 73 trillion USD of other assets.² These loans are primarily residential real estate mortgages, loans from the housing provident fund, and consumption loans, including microlending and peer-to-peer borrowing. Underground lending markets are not included in these figures.

The assets of Chinese households grew much more rapidly than their liabilities between 2000 and 2019, as shown in Figure 2. As a result, Chinese household net worth skyrocketed, increasing more than 16-fold. Household net worth may be more fragile than it appears, however, as discussed later in this paper.

Sources: Center for National Balance Sheet, Seafarer.²

Income

Evaluating income is an important part of understanding a balance sheet, because income is used to service liabilities and grow assets. In 2020, the disposable income of Chinese households (income after income tax and social program contributions) was approximately 7 trillion USD. It is unequally distributed, with the average earnings of an individual in the high-income quintile more than 10 times that of someone in the low-income quintile, as shown in Figure 3.

Source: National Bureau of Statistics of China.

Household income comes from wages, social transfers, business income, and property income (income from rental properties and financial assets), as shown in Figure 4. Social transfers include the net receipts of pensions, social and medical insurance programs, and income support programs to households. Wealthier households tend to earn more of their income from business and property income; poorer households rely more on transfers.

Source: National Bureau of Statistics of China.

The true level of household income in China has long been debated. Unreported income – often referred to as hidden or grey income – is believed to be significant. One study estimates that household income in 2008 was underreported by as much as 66%.³ The level of underreporting was skewed sharply toward high-income earners, who are better able to hide business and investment income. According to economists Thomas Piketty, Li Yang, and Gabriel Zucman, household income surveys massively underreport the incomes of China’s wealthiest households.⁴

Precise estimates of unreported income are by definition impossible to obtain. What can be said with some confidence is that household incomes in China are moderately to substantially higher than reported and that high-income earners disproportionately underreport their income levels. Measurements based on the ratio of debt to income are therefore likely to understate the actual debt-servicing capacity of households.

Official statistics show rapidly deteriorating debt sustainability for Chinese households, as shown in Figure 5. Outstanding household debt was about 9.6 trillion USD in 2020.

Sources: National Bureau of Statistics of China, Bank for International Settlements, Seafarer.

As household income is both understated and unequally distributed, aggregate debt-to-disposable income may not accurately represent the risks to the Chinese economy. A better understanding of the composition of assets and liabilities on the household balance sheet is needed to obtain a clearer picture. Lower-income households in China are less likely than other households to have debt, but those that do face very high debt burdens, as shown in Figure 6. Moreover, much of this debt is from the shadow banking system, which typically charges higher interest rates.

Wealthy Chinese households own more homes and have more total debt than less wealthy households, but their debt represents a smaller share of their income. Given the evidence that income is underreported for high earners, the debt-to-income ratio may be even more favorable for wealthy households than official statistics indicate.

Linkages

The household balance sheet does not exist in isolation. It is intertwined with the corporate, government, and financial sector balance sheets.

Linkages with the Corporate Balance Sheet

One of the primary links between the household and corporate balance sheets is through equity. Equity owned by Chinese households is the second-largest asset on the household balance sheet, at about 23 trillion USD as of the end of 2019.⁶ This figure includes listed equities held directly by households and corporate equity that is indirectly owned (all domestically-held corporate equity is ultimately owned by either households or the government).

Given China’s long-standing capital controls, households have a significant home bias in their holdings of equity. This bias heavily exposes Chinese households to the volatility of the domestic A-share market. Indirect corporate equity held by households is also overwhelmingly domestic. The lack of international diversification means that an economic downturn in China will have a large impact on the value of household equity holdings.

Income is another important linkage between the household and corporate balance sheets. Household income is derived largely from the corporate sector, through wages, business income, and investment returns (see Figure 4). Periods of corporate distress are likely to result in lower income to households through all three of these channels.

Corporate debt may sometimes manifest itself as a household liability. In China, owners of closely held businesses often pledge their assets to help secure loans for their company. During a period of financial distress, companies also sometimes receive capital injections from their owners’ personal assets. Through these interlinkages, corporate debt can be transmitted to household balance sheets.

Linkages with the Government Balance Sheet

The household sector both funds the government (through tax payments and social security contributions) and receives income from the government (via transfer payments).

Relative to GDP, the overall rate of taxation is lower in China (22.1%) than in OECD countries (33.8%).⁷ Personal income taxes make up a much smaller share of China’s total tax revenues, as shown in Figure 7.

China does have relatively high social security contributions rates. They include contributions to pensions and to social and medical insurance programs. These contributions are largely distributed back to households in the form of transfer payments. The net effect on household income may be neutral, but these transfers do have a redistributive effect within the household sector, as poorer households receive more in benefits than wealthier ones.

If the government’s balance sheet comes under stress, it could lead to cuts in social spending, which would disproportionately hurt lower-income households. These transfer payments account for about a fifth of total household disposable income. China’s local governments are responsible for administering many of these benefits. Some of them are in weak financial shape.

Linkages with the Financial Sector Balance Sheet

The liabilities on the household balance sheet are almost exclusively owed to the financial sector. Households borrow from banks to purchase homes and vehicles, fund other consumption, and operate businesses.

Households also hold significant assets in the form of claims against the financial sector. The largest such asset is the more than 16 trillion USD in deposits held at banks. The share of Chinese household wealth in deposits has historically been high because the country’s undeveloped financial system provided savers with few safe options outside of low-yielding deposits. Households also hold assets in the form of insurance policies and equity in financial institutions.

Households rely on credit from the financial sector to consume and invest at higher levels than they would if they were forced to rely on their own savings. The financial sector, in turn, relies on households to provide the deposits it uses to extend loans and other forms of credit.

Imagining a Major Real Estate Correction

At over 33 trillion USD in value, real estate is the single largest component of the Chinese household balance sheet.⁸ The strength of that balance sheet depends on the value of residential real estate remaining high. At the end of 2019, real estate accounted for 43% of total household assets in China, almost twice the share for U.S. households.⁹

Holding a large share of total wealth in real estate can be problematic for several reasons. First, real estate exposure is usually undiversified, as property tends to be held in a single market. Homeowners are therefore heavily exposed to local property market risks.

Second, real estate is relatively illiquid. Most residential properties cannot be easily subdivided and sold into smaller components. Real estate sales have long lead times and high transaction costs relative to most financial assets. China’s home equity loan regulations are restrictive, making it hard for homeowners to take cash out of their properties. In addition, the rental market in China is underdeveloped, making it hard to turn an extra home into an income stream (homeownership rates in China approach 90%, compared with a global average of about 69%).¹⁰

There are worrisome signs that Chinese home prices have grown at an unsustainable rate. Home prices in China increased by 411% between 2000 and 2020, almost four times as quickly as in the U.S.¹¹ Home prices increased significantly more rapidly than rents – often an indicator of stretched valuations.

The price-to-rent ratio – the ratio of the average listed price of properties for sale to the average annual rental rate – can help project the magnitude of a possible decline in housing prices. Rental rates are an indicator of the potential “return” on a housing asset. The higher the ratio, the more stretched real estate valuations may be. Price-to-rent ratios above 20 are associated with expensive housing markets (the average for the U.S. was about 18 in 2021).¹²

A recent study estimates that the average price-to-rent ratio for Chinese cities was about 36 in 2020.¹³ It finds that the average ratio in China has been close to 30 since at least 2015.¹³

Although this ratio can remain elevated for a long time, it can still be used to estimate a correction that would bring Chinese housing prices back closer to normal levels. Assuming rents remain constant, Chinese home prices would need to contract by about a third to bring the average back to 24, a level considered high but significantly lower than the current level.

Effects on the Household Balance Sheet

A real estate correction would have significant impacts on household assets, net worth, and income, as shown in Figure 8.

Sources: Household Finance Research Center, Southwest University of Finance and Economics.

Effect on Assets

The most direct impact on the household balance sheet would be a decline in asset values. A 33% drop in home prices implies an almost 11 trillion USD reduction in the value of household real estate assets.

Declines in real estate prices would also be correlated with falling equity values. Property developers, construction firms, and other real estate-linked industries would face declining equity values. Property is also an important component of corporations’ fixed assets.

China’s A-shares are volatile and often experience large drawdowns. The largest drawdown in recent history took place between June 2015 and January 2016, when the MSCI China A Index fell by 50%.¹⁴ A similar drop would imply a decline of 12 trillion USD in household net worth.

Effect on Liabilities and Net Worth

Household liabilities would not change if the housing market declined, as mortgages are not adjusted for declines in home value.

Total household net worth can shift dramatically during periods of economic distress. Between the fourth quarter of 2007 and the first quarter of 2009, for example, U.S. household net worth dropped by more than $11 trillion, as a result of the global financial crisis.¹⁵ In the first quarter of 2020 alone, U.S. household net worth dropped by more than $6 trillion (a decline of over 5%), as a result of the Covid-19 pandemic.¹⁵

In a severe Chinese real estate correction, declining housing and equity values could reduce household net worth by 23 trillion USD, or 31% of the total. A drop of this magnitude would have a major negative wealth effect.

Faced with a reduction in their wealth, households would likely lower their consumption levels. Research on negative wealth effects is still ongoing. One study of U.S. households finds that a 10% reduction in housing and financial wealth reduces consumer spending by 0.56-0.90%.¹⁶ The impact on Chinese households might be larger, because of higher exposure to real estate. The ultimate effect on the economy may be lower, however, because of the smaller role consumer spending plays in driving Chinese economic growth.

Effect on Income

The impact on household incomes would be less severe than the drop in asset prices, but it would still be significant. Wage income would decline, particularly for people employed in the real estate or construction industries. Transfer payments might be cut, as local governments struggle to finance their budgets with lower land sale tax revenues. Property income would fall, as companies cut dividends and fail to make interest payments, and rental earnings decline. Business income would weaken, as a decline in the housing market drags down overall economic growth.

Assessing the Strength of the Household Balance Sheet

The centrality of real estate for both households and the Chinese economy mean that a housing price correction is likely to be extremely painful. To analyze the resiliency of the household balance sheet in the face of such a scenario, we use the factors outlined in China’s National Balance Sheet – A Framework for Analysis: interdependency, solvency, liquidity, and composition.

Interdependency

China’s household balance sheet has significant interdependencies with the corporate, government, and financial sector balance sheets. A real estate correction would affect all of China’s subnational balance sheets. For the household balance sheet, the largest interdependency is the drop in the value of corporate equities and lower income from the corporate sector. In a prolonged downturn, the government may cut transfer payments and raise income taxes, in order to offset falling tax revenues. If the financial sector is in distress, households will be able to borrow less from banks to finance investment and consumption.

Solvency

Even after a housing market correction, Chinese households would still have significant equity in their homes. Prudential controls for mortgage borrowing have ensured that loan-to-value ratios in China remain moderate. First-time buyers are required to make significant down payments, typically 30%.¹⁷ Second homes require even higher down payments, sometimes as high as 70%. These down payments, combined with home price appreciation, mean that most Chinese households have a significant equity buffer in their homes.

Even in a large housing price correction, many Chinese homes would not be underwater (when the property is worth less than the amount owed on the loan). Their continued solvency may reduce the risk of widespread strategic defaults by homeowners and reduce bank losses during foreclosures.

The decline in the value of corporate equities would also be significant, but the household sector would still have high net worth. A 31% drop would bring household net worth roughly back to where it was in 2016.

Liquidity

The high rate of savings in China increases the ability of households to weather shocks to their incomes. Chinese households save an amount equal to about 23% of GDP each year – significantly more than the global average of 7%.¹⁸ This amount far exceeds total annual household debt payments and implies that households may be able to continue to service their debts even in the face of large declines in household income.¹⁹ Indeed, a study by the International Monetary Fund estimates that a 10% decline in income for Chinese households would lead to only a modest increase in financial distress (less than 5 percentage points for most income brackets).²⁰

Mortgage forbearance is an important tool with which to address short-term liquidity shocks. In the U.S., the complex and interlinked system of mortgage securitization made it difficult for financial institutions to adjust payments for borrowers during the global financial crisis. Mortgage securitization in China is significantly less developed than in the U.S. At the end of 2020, China had about 184 billion USD in residential mortgage-backed securities outstanding – a fraction of the more than $11 trillion in the U.S.²¹ As a result, Chinese banks may be better positioned to offer forbearance to borrowers while the economy recovers.

Composition

A real estate correction would play out very differently across individual household balance sheets. The period immediately after a home purchase is when equity levels in a home are likely to be lowest and the burden of mortgage payments highest. Low-income households have the highest debt-to-income ratio but are also the least likely to have debt, as shown in Figure 9. Middle- and high-income households have much healthier debt-to-income ratios. A housing market downturn would create financial distress for many households, but the income groups that are more likely to have debt are also better positioned to service that debt.

Outlook for the Household Balance Sheet

Chinese households have strong balance sheets, but that strength is tightly linked to housing. A severe real estate correction would have significant impacts on the income and wealth of Chinese households. The household balance sheet would remain amply solvent in the short run, however.

Over the long term, a healthy housing market is essential for the household balance sheet. The centrality of real estate to the Chinese economy means that the impact of a housing correction would be felt far beyond the real estate and construction industries. One study estimates that real estate is indirectly linked to 29% of economic activity in China and that a 20% decline in housing activities could lead to a 5-10% decline in GDP.²²

Can China prevent a short-term correction in prices from becoming a long-term housing market depression? Many analysts believe that housing demand in China is weakening, as a result of slower population growth and migration from the countryside to urban areas.²³ At the same time, demand for housing in China’s wealthy coastal cities appears to be strong, even in the face of hukou restrictions and limits on nonresidents purchasing homes. China’s housing market could experience a sharp divergence between lower-tier cities and the wealthy megacities of Beijing, Shanghai, Guangzhou, and Shenzhen.

The Chinese government is perhaps the most important force preventing a long-term housing market depression. China often uses the property market as a tool to support economic growth. It has shown that it is willing to invest significant resources to support the housing market.²⁴ For example, when the housing market ran into significant trouble in 2014, the government mobilized to support the real estate industry. It launched the national slum redevelopment campaign, tearing down old buildings and giving residents funds to purchase units in new buildings. The program created a new source of real estate demand that helped cushion the industry through a period of overcapacity. Between 2015 and 2020, an estimated 11 million units were “cleared” as part of the campaign.²⁵ Lending to support the program came from the state-owned China Development Bank, which itself was bolstered by trillions of Renminbi in loans from the People’s Bank of China.²⁵ After a few years, the property market was able to work through the surplus inventory and return to stronger footing. Facing a major real estate correction, the Chinese government is unlikely to stand by the sidelines as the property market drags down the entire economy.

The views and information discussed in this commentary are as of the date of publication, are subject to change, and may not reflect Seafarer’s current views. The views expressed represent an assessment of market conditions at a specific point in time, are opinions only and should not be relied upon as investment advice regarding a particular investment or markets in general. Such information does not constitute a recommendation to buy or sell specific securities or investment vehicles. It should not be assumed that any investment will be profitable or will equal the performance of the portfolios or any securities or any sectors mentioned herein. The subject matter contained herein has been derived from several sources believed to be reliable and accurate at the time of compilation. Seafarer does not accept any liability for losses either direct or consequential caused by the use of this information.

1. Yang Li, Xiaojing Zhang, et al., “China’s National Balance Sheet – 2020 (中国国家资产负债表2020),” Center for National Balance Sheet, National Institution for Finance and Development, Chinese Academy of Social Sciences, December 2020.
2. See Yang Li, Xiaojing Zhang, et al., “China’s National Balance Sheet – 2020 (中国国家资产负债表2020),” Center for National Balance Sheet, National Institution for Finance and Development, Chinese Academy of Social Sciences, December 2020; and “Balance Sheet of Households and Nonprofit Organizations, 1952–2021,” Board of Governors of the Federal Reserve, 23 September 2021.
3. Xiaolu Wang and Wing Thye Woo, “The Size and Distribution of Hidden Household Income in China,” Asian Economic Papers, January 2011.
4. Thomas Piketty, Li Yang, Gabriel Zucman, “Capital Accumulation, Private Property, and Rising Income Inequality in China, 1978-2015,” National Bureau of Economic Research, June 2017.
5. “A Report on the Leverage Ratio and Consumer Credit Usage (中国居民杠杆率和消费信贷问题研究报告),” Southwest University of Finance and Economics, Chinese Household Survey and Research Center, and Ant Finance Group Research institute, 17 October 2019.
6. These equity holdings comprise both corporate equity and a significantly smaller amount of equity in financial institutions.
7. “Revenue Statistics in Asia and the Pacific 2021 ─ China,” OECD, 2021.
8. Urban dwellings account for the vast majority of real estate value in China. The methodology used to calculate the value of urban dwellings uses the floor space per capita, the average selling price of residential new buildings, and the urban population. The stock of existing housing is depreciated by 2.4% a year. This methodology may overestimate the value of the housing stock if older housing units do not experience equivalent price appreciation compared with new units or the actual depreciation rate is higher than 2.4%. See Cheng Li, “China’s Household Balance Sheet: Accounting Issues, Wealth Accumulation, and Risk Diagnosis,” Institute of Economics, Chinese Academy of Social Sciences, National Institution for Finance and Development, 26 June 2017.
9. See Yang Li, Xiaojing Zhang, et al., “China’s National Balance Sheet – 2020 (中国国家资产负债表2020),” The Center for National Balance Sheet, National Institution for Finance and Development, Chinese Academy of Social Sciences, December 2020; and “Changes in Net Worth: Households and Nonprofit Organizations, 1952 – 2021,” Board of Governors of the Federal Reserve, 23 September 2021.
10. “Li Yang: Beware the Risk of Falling House Prices to Prevent the Emergence of “Negative Equity” (李扬: 警惕房价下跌风险 防止出现 “负资产”),” China Economic Network, 1 September 2021.
11. Jonathan Woetzel, et. al, “The Rise and Rise of the Global Balance Sheet: How Productively Are We Using Our Wealth?” McKinsey Global Institute, 15 November 2021.
12. Ben Geier, “Price-to-Rent Ratio in the 50 Largest U.S. Cities – 2021 Edition,” SmartAsset, 25 May 2021.
13. Joseph Gyourko, Xiaodan Wang, Jing Wu, Rongjie Zhang, “Hukou and Homeownership Premiums: A Study of Chinese Price-to-Rent Ratios,” National Bureau of Economic Research, 17 May 2021.
14. “MSCI China A Index,” MSCI, 29 October 2021.
15. “Changes in Net Worth: Households and Nonprofit Organizations, 1952 – 2021,” Board of Governors of the Federal Reserve, 23 September 2021.
16. Dimitris Christelis, Dimitris Georgarakos, Tullio Jappelli, “Wealth Shocks, Unemployment Shocks and Consumption in the Wake of the Great Recession,” Household Finance and Consumption Network, The European Central Bank, March 2015.
17. Kaiji Chen, Qing Wang, Tong Xu, Tao Zha, “Aggregate and Distributional Effects of LTV Policy: Evidence from China’s Micro Data,” National Bureau of Economic Research, November 2020.
18. Longmei Zhang, et al., “China’s High Savings: Drivers, Prospects, and Policies,” International Monetary Fund, December 2018.
19. 20% of Chinese GDP in 2020 is equal to nearly 3 trillion USD. Outstanding household debt for the same period is 9.5 trillion USD. Assuming an average maturity of 15 years and an interest rate of 5.5%, annual household debt payments should be less than 1 trillion USD a year.
20. Fei Han, Emilia Jurzyk, Wei Guo, Yun He, Nadia Rendak, “Assessing Macro-Financial Risks of Household Debt in China,” International Monetary Fund, 27 November 2019.
21. See Jian Chen, Yihai Yu, “Chinese RMBS: A Way to Diversify Fixed-income Portfolios?,” MSCI, 7 July 2021.; and “U.S. Mortgage Backed Securities Statistics,” SIFMA, 11 November 2021.
22. Kenneth Rogoff, Yuanchen Yang, “Peak China Housing,” National Bureau of Economic Research, August 2020.
23. Ning Zhang and Wang Tao, “What Do You Need to Know About China’s Property Sector?,” UBS Global Research, 28 September 2021.
24. Zhang Bin, Zhu He, Zhong Yi, “How to Prevent the Risk of a Hard Landing in the Real Estate Market (如何防范房地产市场硬着陆风险),” New Finance Review, China Finance 40 Forum, 16 November 2021.
25. Tom Orlik, China: The Bubble That Never Pops (Oxford: Oxford University Press, 2020).