China is facing the most serious economic challenge in its modern history, as the ongoing collapse of the real estate market has triggered an unprecedented debt crisis, exposing the fragile foundations on which the “Chinese miracle” was built. Today, the debts of local governments and their financing vehicles (LGFVs) have soared to 134 trillion yuan, or $18.9 trillion, one of the highest levels of public debt in the world.
For the first time in decades, China cannot buy time with the old recipe of massive credit expansion. Debt has already reached levels that threaten its fiscal and financial stability. The question is no longer whether there will be a crisis, but how big and when.
The collapse of the real estate market and the end of the Chinese growth model
The five-year slump in the real estate market shows no signs of recovery. The failure of Vanke – the last major state-backed real estate company – confirms that the sector is in a systemic crisis, not a temporary correction.
Land sales, the main source of revenue for local governments, have collapsed from 8.7 trillion yuan in 2021 to just 3 trillion yuan in 2025. More than 10% of available properties are not receiving a single offer, underscoring the collapse in demand. When land purchases stop, so does financing for local development. This is where the biggest explosion of public debt in Chinese history begins.
Record Debt and Unbridled Bond Issuance
Local governments are rushing to plug the holes with new borrowing. Local bond issuance has already exceeded 10 trillion yuan, breaking all previous historical records. The total outstanding local bonds have reached 54 trillion yuan, while the “hidden” debts of LGFVs are estimated at 87 trillion yuan. In other words, almost half of China’s GDP is hidden in shadow debt, outside of official Chinese statistics.
Most worryingly, LGFVs are not operational. Only 3% show a return of more than 4%, while almost 10% are loss-making. In 2024, LGFVs received more than 1 trillion yuan in subsidies, an amount more than double their profits. In practice, without Beijing’s liquidity injections, the entire mechanism would have collapsed.
Deflation and low interest rates
The People’s Bank of China (PBOC) is trying to keep the system afloat through record interest rates and massive liquidity. The average yield on LGFV bonds in Beijing has fallen to 2.1%, a level reminiscent of Japan’s negative interest rate era.
But deflation, which at first looks like “debt relief,” is turning into fiscal poison. Nominal growth is plummeting to 3%, dangerously close to borrowing costs, breaking the so-called Domar Condition – the fundamental criterion for debt sustainability. When nominal growth does not exceed borrowing costs, debt grows out of control.
Unless the PBOC adopts negative interest rates and aggressive quantitative easing, the debt crisis will rapidly worsen.
Beijing is buying time
Faced with the risk of systemic collapse, the Xi administration has been steadily approving new stimulus packages. In October, the Ministry of Finance announced a new 500 billion yuan program, while the government gave the green light to a new 10 trillion yuan issuance of local government bonds, transferring LGFV debts to municipalities. But this tactic is a fiscal patchwork: it shifts the problem from one side of the balance sheet to the other, without restoring sustainability.
Capital controls, exporting deflation
China maintains three artificial defenses: strict capital controls, a huge trade surplus, and state-sponsored credit.
According to Thanos Hondrogiannis of Trust Economics, this strategy is not from a position of strength, but of absolute necessity. China must continue to export deflation because its domestic economy is unable to absorb the extent of the debt.
But international demand is slowing, foreign exchange reserves are under pressure, and Beijing’s ability to control all variables is waning. What will happen when China can no longer finance itself.
The China of 2025 is not the China of 2008. It is no longer the global savior of a new wave of growth, but the greatest systemic risk to the global economy. With a real estate market reminiscent of the US before 2007, a Japanese-style fiscal debt trap and deepening deflation, Beijing is walking a fine line, trying to prevent a Lehman Brothers 2.0. This time, unlike 2008, there will be no China to save the world…
